Winton Bates' Freedom and Flourishing

One of the most thoughtful blogs around is Winton Bates' Freedom and Flourishing.It's not always easy to read. That's not a criticism, simply a refection of the subject matter.

Winton's most recent posts ( How do preferences relate to well-being? and Should we expect the rules of a good society to be good for everyone?) bear upon a topic that has worried me, the increasing tendency of Governments to make decisions "for our own good."  This is creating something of a policy and administrative mess.   

Australia increases official interest rates - again!

Today's official interest rate increase by Australia's Reserve Bank has received global coverage. Who would have thought it? We are just not used to this focus! 

Australia's remarkable economic performance

It's really very interesting, and it's also very unusual, for the Australian economy to decouple in the way it has from the developed world. It's also interesting to look back at previous forecasts.

The chart shows official Australian forecasts of GDP at the start of last November. At that stage, Australia was expected to be the only developed country other than Canada to stay in positive growth territory.

Following these forecasts,the global outlook worsened and Australian pessimism set in, something that I tried to fight against. All the forecasts went quite negative.

In recent times, Australia has been clawing back. Interest rates have started to rise, the Australian Government is looking to trim stimulus, and house prices have boomed.

The attached chart shows the latest Australian Treasury forecasts for GDP growth. Australian GDP growth in 2009 is now expected to be greater than that projected in November.

Australia is unusual as the only developed country now expected to show positive GDP growth in calendar 2009.

How real is all this?

It's real enough, although in Australia as in other countries Government stimulus packages played a major role in countering the downturn.

The issue that Australia now faces is what's next. And here there are some interesting variables indeed.                

Interest rate rises, the balance of payments and the Australian economy - August 09 trade figures

I watched the global reaction to the Reserve Bank's decision to raise interest rates with a degree of bemusement. To paraphrase one overseas story, it was a case of a one trillion dollar economic tail wagging the global market dog. I guess it shows how much concern is still around.

A key reason why I was more optimistic about the Australian economic position last year than most was the sudden strengthening in Australia's trade position. To my mind, this gave Australia an added economic buffer. The trade position has now gone into reverse.

   The August trade figures were released by the Australian Bureau of Statistics on 6 October. They confirmed a continued deterioration in Australia's trade position.

The attached graph from ABS shows the balance of trade on goods and services. You can see clearly how the trade position improved over 2008, then went into reverse in the early part of 2009.

The next graph shows Australia's imports of goods and is quite instructive. You can see how Australia's economic expansion led to the country sucking in increasing overseas goods. This went into reverse at the end of 2008.

Imports of services displayed a somewhat similar trend, although service imports are now displaying a stronger upward trend.    

Now the point here is that our balance on goods and services has deteriorated in spite of a decline in imports of goods.

The reason for this lies in a decline in the value of our exports of goods; service credits are essentially flat lining.

The next graph shows our exports of goods. You can see just how steep the decline in the value of our exports has been since the peak at the end of last year.

I haven't attempted to disentangle the price and volume effects in the figures, nor have I looked at compositional issues. I think that the raw numbers are sufficient for present purposes.

Just as the improvement in Australia's trade position provided a buffer leading into the global turn down, the deterioration now provides a constraint on economic growth.

As the Australian economy expands, additional imports will be sucked in. Without additional exports, the consequent deterioration in the balance on goods and services must constrain growth.

In theory in a world of floating exchange rates, the Australian dollar should depreciate to balance any deterioration. In practice, in at least the short term, the Australian dollar moves at variance to the economic fundamentals. Just as the fall in the value of the ozzie last year was not supported by the fundamentals, I would now question the size of the rise.

During the week I heard one commentator suggest that Australia was now, in economic terms, in a group of its own. Others suggested that demand for commodities especially from China was the proximate cause of Australia's better performance.

If you look at the numbers, it seems to me that Australia is in fact in the same position as most countries, if a little more fortunate. We are just as dependant as other countries on improved economic conditions if the current recovery is to be sustained.        

Economic planning for the longer term - introduction

This time last year we were in China. The global economic storm broke while we were in Shanghai and continued in Beijing. There was something a little eery about it all.

Twelve months later and with the economic outlook apparently improving all the time, political debate in Australia has switched to the right time and way of ending current stimulus measures.

The Government argues that now is not the right time. The stimulus measures have a natural phase down, while economic risks remain. The opposition counters that Australia is building debt and that the stimulus measures are no longer necessary. Even the Greens in an unusual display of fiscal rectitude have argued that a stimulus phase down should at least be considered.

The debate will work itself out through the usual political processes. A far more interesting question to my mind is just what Australia might do to strengthen its position in future downturns.

Australia has been remarkably lucky. The country went into this global downturn with a budget surplus and no net Commonwealth Government debt. Our balance of trade in goods and services went surplus at just the right time, while a depreciated exchange rate totally removed from economic fundamentals provided a further cushion. Export volumes, too, held up better than expected because of continued Chinese buying.

All this provided a cushion that made it easier for Australian Governments to respond to the crisis. We may not be so lucky again.

To set a context for this I want to point to a few things.

The first is the Australian sense of optimism as exemplified by this discussion reported by Robert Gottliebsen. I will comment on the detail a little later. For the moment, I simply note that optimism can blind Australians to the problems the country faces.

The second is climate change.

I remain sceptical about some aspects of the argument, but I do have to accept two things. The first is that the majority of the scientific community accepts climate change. The second is that, regardless of the accuracy of the majority view, most officials and opinion leaders accept the majority view, as does a substantial proportion of the world's population. This means that things will happen  

The third is timing.

The last major recession bottomed in the middle of 1991. That's a very long time ago, but major economic cycles take time. All the current official thinking appears to deal with ways of controlling/stopping crashes through additional regulation. It hasn't worked in the past. I see no reason why it should work in the future. Regardless of regulation, we will have another crash.

So we need to be thinking in a ten to fifteen year time horizon. And that is just the period during which policy responses to climate change will start to really bite.

We need to start planning now.    

Staff performance measurement in Australia's universities

According to a story in the Australian Financial Review (Monday 24 August 2009) by Joanne Mather, and I quote:

Vice-chancellors are deploying corporate style tactics to lift employee output and create leaner, more responsive workforces before a new era of performance-base funding agreements with the Commonwealth.

This example of modern corporate-speak took me by surprise. In the same story, Joanne quoted the VC of the University of Canberra, Stephen Porter. Speaking of the introduction of performance based at his university, he said: This wouldn't raise an eyebrow in the corporate sector.

I am sure that Professor Parker is right. My problem is that I am far from sure that the corporate sector is in fact the right model. I thought this before, but since then we have had to global financial crisis caused in part by by the combination of performance measurement and performance based pay.

To extend this argument consider the words used by Joanne Mather in her first paragraph quoted above.

Note, first, the use of the word employee. Of course university staff are "employees", but they are also more than this. I wonder how the focus on "employees" fits with other (perhaps outdated) concepts - community of scholars and academic freedom are two that come to mind.

Still continuing with Joanne's word, the aim of the new approaches is to increase "output". This got me wondering. Just how the universities are to measure this? How might this be related to individual performance?

I tried to think through just how I might measure output. Universities are complex multi-variate institutions. To really develop a working output model, you first have to specify the outputs, then determine the relationships between these outputs and the various elements (inputs) contributing to the outputs. I can see how I might do this in a general sense, but I find it hard to see how to it with the degree of specificity implied by Ms Mather's comment.

The use of the word "lean" in the way that Ms Mather uses it originally came from lean manufacturing, the slimming down of manufacturing systems to gain maximum value in process terms while minimising inventory. Later it became fashionable in corporate restructuring - getting rid of fat to create the lean organisation.

The results of this approach in the corporate sector have in fact been very mixed. A particular problem has arisen in balancing short term gain with long term risks and costs. In Australian electricity distribution, for example, the newly corporatised or privatised entities cut the number of linesmen. This did provide a short term gain that flowed to the bottom line, but later led to severe shortages with added costs in recruitment and training, as well as reduced operational efficiency.

Of course, a more responsive workforce is (in general) a good thing. Here, however, a question has to be asked: responsive to whom? In the university case, responsiveness to corporate demands can conflict with corporate objectives or indeed academic and professional responsibilities.

I actually do think that Australian universities need to be more responsive in meeting student needs and in the development and modification of courses. One project that I worked on involved the development and introduction of a new vocational course. This should have been relatively simple. The project failed because the university, a major metropolitan institution, simply could not get its act together.

The point about this example, however, is that the delay linked to the interaction between people and systems. This was the core reason for delay and final abandonment.

Apart from my own concerns about what I see as a decline in the real standards of Australia's universities, my experience as a consultant makes me very cautious. Speaking as someone who argued strongly for the adoption of corporate approaches into the public and not-for-profit sectors, I no longer see the gains I used to.       

China and the US - savings and investment

Interesting discussion at dinner last night with a member of the board of a major Australian retailer who argued that the Australian economy was far more fragile then people realised. I am not sure that he is right, but I found the conversation interesting.

There has been a fair bit of discussion since the global financial crisis began about over saving in Asia especially China, over consumption in the west, especially the USA. You will find a sophisticated version of the argument here on Michael Pettis's blog.

This argument confuses me. In this post I want to explain why.

If you look at China, you see a country whose average standard of living is still quite low. You also see a country where there are significant imbalances in wealth across the country. China needs to increase the standard of living for its people, while also ensuring a more even spread.

To do this, China needs to fund investment. This has to come from local savings or from overseas capital. A high local savings rate is not a bad thing in these circumstances.

Leaving aside export subsidies or an artificially low exchange rate, these are different issues, China's semi-centrally controlled economy has been investing in export related activities. This has generated a major balance on current account surplus, mirror imaged by deficits in other countries. To my mind, this is not a savings problem but an investment one.  

I left aside export subsidies and an artificially low exchange rate. To the degree that these things have occurred exports may increase, but China is also effectively subsidising consumers in other countries. I do not think that this is a sensible longer term strategy.

The suggestion that China should increase consumption for the sake of increasing consumption does not make a great deal of sense to me. Looking at the Chinese position through Australian eyes, the fact that China has been accumulating such large trade surpluses provides an opportunity for the Government to do new things.

This is a bit like what happened here, but on a much grander scale. Australia came through the global downturn so well because and only because our net trade position suddenly improved. This was a necessary but not sufficient condition.

In China's case, the challenges are far greater, but so are the opportunities. If I were an adviser in China, my focus would be on the best ways for China to benefit. Here I am worried by some of Michael Pettis's posts because he points to areas where some of the policy responses do not appear to be very sensible.

In all this, I would not be worried by the US except to the degree that it affected China.

In a post last November, Scoping the global downturn - a few numbers, I looked at relative shares of global GDP. The US has shrunk to a bit over 25%. China is a long way behind at a bit over 6%. My point then was that relativities meant that China could not be the type of universal  cure-all as often presented. This makes me very cautious reading some of the savings/consumption arguments.  

Dreamliner woes

I have been following the story of Boeing's Dreamliner with considerable interest, in part because I used to do consulting work within the aerospace sector, in part because it has clearly become a commercial and management nightmare.

In the most recent development, Boeing has apparently instructed the Italian company Alenia Aeronautica to stop making fuselage components after quality control problems were discovered. For those who are interested in reading back into the saga, Ben Sandiland's has been following it on his Plane Talking blog.

The slowly unravelling story is interesting because it combines so many elements. The Dreamliner is a large, complex project with plenty of scope for things to go wrong. However, Boeing has plenty of experience with this type of project.

I have a strong impression, I may be wrong, that Boeing's difficulties are due in part to the way the company has pushed the technical envelope to try to deliver specific benefits, more to the way in which marketing considerations in general have driven project dynamics.

The relationships between marketing people and engineering and production teams has always been complicated. Let the technical people have their heads and you may get an over-specified product that doesn't meet customer need. Let the marketing people have their way and you end with promises that cannot be met.

The problem for Boeing now is that the project has become a potential company breaker. I suspect that I am not alone in wondering whether the plane will ever enter commercial production.        

Australia's economic outlook - cautions and constraints

Just six months ago, Access Economics' Chris Richardson was all gloom and doom about the Australian economy to the point that his comments triggered a number of posts here and on my personal blog because I just couldn't see it in the numbers. I was far more positive. Now Chris is cautiously optimistic.

Chris' cautious optimism comes at a time of increasing optimism in general reporting in Australia and internationally. Just as the previous gloom and doom led me to check numbers and come to an opposite conclusion, now I am wondering about some of the current reporting. To what degree has the optimism/pessimism effect gone into reverse?

To assess this, I thought that the best way was to look at the reasons why I was more optimistic before, along with my expectations about future developments. I seem to have been pretty right on the first, what about the second?

To begin with, I saw the remarkable change in Australia's trade performance - the switch from deficit to surplus on the current account at just the time we needed it - as central. This, together with an unexpected and in fact unwarranted fall in the value of the Australian dollar, cushioned Australia to some degree and gave the Australian Government far more room to move.

Since then, the value of the Australian dollar has bounced back, while the balance on the current account has turned slightly negative. You can see the latter clearly in the attached chart from the Australian Bureau of Statistics. Remarkable improvement, followed by partial retreat.

I am not too worried by this, I had expected it, but again we need to watch because the current trend means that the balance of trade on good and services has turned from a positive to neutral, potentially negative.

So far as the exchange rate is concerned, I won't comment in this post beyond noting that whereas I had seen the balance of probabilities favouring an appreciation, after the last bounce I think that they are now neutral tending to negative. From my immediate viewpoint, that's not a bad thing.

In terms of my previous analysis, Australia's unexpectedly strong trade position was reinforced by other variables - a budget surplus, no net Australian Government debt - that provided the capacity for the country to manage through the downturn until the global economy recovered.

At the time I did not expect the global stimulus packages to have much immediate impact beyond band-aid until increased Government capital spending kicked in. I also expected capital spend to be far more lagged in Australia and elsewhere than projected by Government because of the nature of intuitional constraints. Overall, I think that the band-aid has been somewhat greater than I expected, the capital spend lags pretty much as expected.

My key concern about Australia and elsewhere lay in rapid increase in liquidity and Government debt. I thought that this was likely to choke growth to some degree as policies went into reverse. This remains my view.

If you look at the chart on the right from Stubborn Mule, you can see how Government gross debt came down and is still at very low levels by global standards. Australia still doesn't have a real problem. The colour bars, by the way, mark periods of Labor Government.

The problem lies in the steady rise in household debt, a lot of which is linked to house purchases.

I have been generally supportive of the Rudd Government's stimulus packages with the notable exception of the First Home Buyers grant for existing houses. This has triggered something of a price boom at the lower price end of the housing marketplace, holding borrowing levels up.

The difficulty with Australia's continuing high levels of household debt lies in the way that interest rate rises create downward economic pressures. Australian interest rates are going to rise over the next two years, and as they do there will be downward pressure on spending in other areas.

I am out of time. I will continue this post a little later.

I said that I expected Australian interest rates to rise over the next two years. At one level, that statement is almost a truism given how low they are now. However, there are still inflationary pressures in the economy.

When I looked at the Australian Producer Price Indexes for June, the thing that stood was the difference between the indices for domestic and imported products. It's quite noticeable that all the major price falls month on month are on the imported side. The year on year position is different, with the rise in price for imported final goods showing a dramatic increase despite recent monthly falls.

My gut judgement, and its not fully supported by the figures, is that price pressures are still there in the more sheltered non or part-import competing sector. On the import side, and excluding exchange rate considerations for the moment, recent price declines are likely to stabilise as the global economy stabilises.

If we now look at the latest CPI figures, the low year on year CPI appears to have been strongly influenced by falls in transportation and insurance and financial services costs. The big increases, all above the Reserve Bank's target inflation band, were education, health, housing, food and alcohol and tobaccos. What can we say about this?

Well, transportation is strongly influenced by fuel costs, so if fuel prices rise as the global economy starts to rise again, we can expect this item to rise. Insurance and financial services costs are strongly influenced by interest rates, and will rise with interest rates.

On the other side of the ledger, the majority of high rise items are in non-import competing sectors and will rise as the Australian economy starts to expand. Rents are already rising. In addition, there are built-in upward factors in education and health. So at least potential CPI and health pressures are still there.

I stand to be corrected on this very simple maths, but it looks to me as though potential inflationary pressures are still present. Should they emerge, then the Reserve Bank will have to think about interest rate rate rise. 

Then we have to factor in Government borrowings. The need to borrow in Australia and overseas to fund stimulus packages will of itself place some pressure on interest rates. So we have a whole set of reasons to expect interest rate rises, with consequent downward pressures on demand.

I now want to bring in a another variable, China.

I have previously expressed concerns about the hope placed on China. Part of this is due to to the relative size of the Chinese economy. It is simply not big enough in absolute terms to have the type of global pull-through effect expected in the absence of growth elsewhere. Part is due to what I see as the vulnerabilities in the Chinese economy itself. Here I am influenced by the writing of Michael Pettis.

I lack the direct knowledge to properly critique Michael's work. But at the very least, it suggests grounds for caution.

This has become quite a long post, so to summarise.

Just as I thought the early gloom about the Australian economy was misplaced, now I am cautious about some of the optimism. Australia is still well placed, that hasn't changed, but I do think that there are some risks and downsides that we now need to factor into our thinking.         

A Stubborn Mule's view of the world

That week I mentioned in my last post proved to be a very long week indeed.

My old friend and colleague Noric Dilanchian kindly pointed me to a Stubborn Mule's Perspective. The writer works in the financial markets in Sydney and is something of a statistical fanatic - a believer in graphs.

I stand somewhat in awe of his statistical skills. Like me, he is interested in patterns. Like me, he likes to test things. However, his statistical skills allow him to do things that I cannot.