Blog Performance October 2010

With only 27 posts this year and no post since 15 August, this blog has been a real Cinderella. This is reflected in the stats.

The attached graphic shows visitors (yellow) and page views ) yellow plus red) for the year to the end of October.

The slump in numbers is easy to see. Current traffic is all search engine from previous posts.

Over the last month, the most popular posts were:

• The Importance of Demography and Demographic Change - update 65 page views
• Slow posting 57 page views
• Economic implications of the Australian Government's Nation Building package 24 page views
• Common Management Problems Series 1 - managing up 19 page views
• A continued apology for slow posting 15 page views
• Mechanistic Management - the sometimes fallacy of planning 14 page views
• Global Demographic Trends - Asia 11 page views
• Changes in Public Administration and their Impact on the Development of Public Policy 1 - Introduction 10 page views
• Australian Government's new stimulus package 8 page views
• Increase in the New Zealand cash rate 7 page views.

Pettis, China and the nature of structural imbalances

I have a lot of time for the views of Professor Michael Pettis. However, I am struggling a little with some elements of his analysis: it may be simply a lack of understanding on my part; it may be that we have different perspectives on time horizons; or perhaps a combination. Since I think that the issues are important, I decided to set down my confusions.

Let me start by outlining Professor Pettis's arguments as I understand them. I accept that I may be guilty of gross simplification; readers please correct me.

China has been following an Asian development model. This involves a focus on export led growth combined with a strong focus on capital investment. Consumption is squeezed to fund capital investment. The outcome in the Chinese case has been rapid growth combined with large export surpluses.

All this sounds pretty good, but there are problems. With time, structural imbalances emerge in the economy. Both capital investment and export activities are effectively subsidised from other parts of the economy. With time, these subsidies become more difficult to maintain: real returns on capital investment fall and may in fact become negative; investment and exports become so large relative to the rest of the economy that simple maths make it increasingly difficult to maintain the process; exports themselves become a problem.

By definition, trade surpluses in one country have to be matched by deficits elsewhere. When a country is small, this is not a problem. However, when the volume of exports and the consequent surplus becomes large relative to the size of world trade, surpluses are harder to maintain. In the Chinese case, the very large Chinese surpluses are especially matched with US trade deficits. The Chinese surpluses on the current account then flow into the US on the capital side; China effectively funds US consumption.

The logical answer to the growing structural imbalances is an expansion in Chinese consumption, thus increasing the size of the consumption share of the economy and of imports. The Chinese surplus declines, as do deficits in other countries. However, the sheer size of the structural imbalances makes this difficult to achieve. It is easier in political terms to continue with current policies even though this creates a growing risk of disaster.

Other factors are involved as well. One is the high Chinese savings rate, itself a mirror image of the investment process.

Accepting that my analysis of Professor Pettis' views may be simplistic , the confusion that I have links to the nature of the adjustment process. It is not clear to me that a simple expansion in consumption is the answer.

There are, I think, two very different sets of issues involved. One is the the nature of the structural imbalances that have emerged in the Chinese economy, the second the trade adjustment process. Let's leave aside the structural imbalances in the Chinese economy, focusing instead just on the trade adjustment process.

On the capital side, and as happened with the UK in the nineteenth century when it had a major funds surplus, I would expect long term Chinese overseas investment to rise. This means that an increased proportion of Chinese funds would be invested in specific off-shore activities rather than US denominated securities. This investment will lead to increased economic activity in other countries that will, of itself, affect trade flows. Those countries will buy more international goods and services as a consequence.

On the current side, and again as happened with the UK in the nineteenth century, rising Chinese living standards will lead to increased consumption. However, there is a scale and timing issue here. The sheer scale of the economic transformation including urbanisation taking place in China dwarfs anything seen before. I haven't attempted to run any rough numbers, but if you add an extra 400 million urban dwellers to a regular % increase in Chinese consumption associated with rising living standards, then you get some very large numbers indeed in the medium term.

This process may not shift the ratio between consumption and investment as usually measured as much as might be expected simply because so much capital investment is required. However, it will certainly lead to shifts in the trade balances. My feeling is that current Chinese surpluses may be more ephemeral than people currently realise.

None of this says that the short to medium term impact of structural imbalances in the Chinese economy is not important. I just think, and I am sure that Professor would agree, that we need to look at all the factors involved.          

Cloud computing, risks and returns

I have watched the growth in cloud computing with interest. Wikipedia defines cloud computing this way:

Cloud Computing is Internet-based computing, whereby shared resources, software, and information are provided to computers and other devices on demand, like the electricity grid.

The ideas behind cloud computing are not new. What is new is simply the question of scale facilitated by technological and market change.

Despite the growth, I was interested to see an article by Gordon Peters on IT Wire suggesting that almost half of Oceania IT professionals say that the risks of cloud computing outweigh the benefits, according to the first ISACA Oceania IT Risk/Reward Barometer survey.

ISACA says that CIOs are increasingly interested in cloud computing because of its potential to deliver lower total cost of ownership (TCO), higher return on investment (ROI), increased efficiency and pay-as-you-go services, and that IDC has said that cloud services will outpace traditional IT spending over the next five years, representing approximately $51 billion by 2013.

“Yet IT professionals see risks in entrusting information assets to the cloud,” according ISACA which recently surveyed 218 Australia and New Zealand-based IT professionals who are members of the global, non-profit professional association.

I can understand the cautions, but also think the short to medium term economic benefits will continue to drive market growth. What we all do if entire systems go down is, however, a bit of a nightmare.  

Is Australia's trade position as good as it seems?

On 6 July 2010 the Australian Bureau of Statistics released the latest Australian trade in international goods and services figures.

You can see from the attached graphic how the balance of trade on goods and services has returned to positive. This was greeted with a degree of glee. However, the results are not as clear cut as that. 

A very significant contributor to this result was a rise in non-monetary gold exports. These rose in seasonally adjusted terms by $772m or 66 per cent.

We can compare this with:

• an increase in rural exports in seasonally adjusted terms of $235m, up 11%
• An increase in exports in seasonally adjusted terms of non-rural goods of $385m, up 2 per cent.

The main components contributing to the rise in seasonally adjusted estimates for non-rural goods were:

• coal, coke and briquettes, up $329m (10 per cent)
• metal ores and minerals, up $157m (up 3 per cent)
• other manufactures, up $52m (up 4 per cent).

If you look at these numbers, you can see just how important gold was.

If we now look at other aspects of trade performance, I have had a particular interest in services, in part because of the importance of Australia's international education sector. I have been monitoring this closely because I expect this to drop by at least a third over the next year.

The adjoining graphic shows just how flat Australia's service exports have been. The country is simply not doing very well here.

While the overall return to surplus on trade in goods and services is welcome at this point in the cycle, it seems to me to be vulnerable.

In do try to adopt a slightly contrary position in my analysis. By this I mean that I like to test common assumptions and views. I am been concerned for a little while that the structure of our trade has been increasing Australia's economic vulnerability. However, detail here is a matter for another post.  

Australian employment increases May 2010

This graph from the Australian Bureau of Statistics shows the increase in Australian employment since May 2090. As a consequence, the Australian unemployment rate as measured by the statistics has dropped to 5.2 per cent.

In a post on my personal blog, Economic clouds gather, I wondered about the sustainability of the current Australian recovery.

I am still wondering. However, for the moment things remain positive.

Employment is generally a lagging indicator. The continued increase in employment should feed into further growth through increased demand. 

Increase in the New Zealand cash rate

The New Zealand Reserve Bank has increased the New Zealand cash rate because of the strengthening of the domestics economy. Of more interest, was the Bank's perception of the economic outlook.  This is broadly positive.

Profits, performance measurement and management

Over on my personal blog, I have had two posts looking at profits (here and here). Here I just wanted to flag a specific point.

My problems with our current focus on profit fits within the concerns that I started to outline in my reforming Australia's public policy series: the combination of focus with systemic rigidities.

Profit is a good thing. No profits, the business goes down, the economy suffers. In any market system, there will be businesses that can't make enough money and will go the wall. That's part of the economic adjustment process. But what happens when a focus on short term profits starts building instabilities into the whole system?

My view is that we are at this point now.  

Lessons from the national school build program

The Australian National Audit Office's report into the operations of the National school build program makes for fascinating reading for someone like me interested in the details of management. While the report does not provide the type of smoking gun that the Australian opposition would have liked, it does provide an insight into the problems created by the Rudd Government policy approach and associated administrative structures and styles.

Although no-one so far has looked at the connections, this is in fact the second report into the operations of what are called National Partnership Agreements. The first came with the release by Indigenous Affairs Minister Jenny Macklin at the end of August 2009 of a report reviewing the initial operations of the $672m Strategic Indigenous Housing and Infrastructure Program. This program became part of the National Partnership Agreement on Remote Indigenous Housing and was intended to deliver 750 new houses by 2013 in Northern Territory remote indigenous communities. My then analysis of the report can be found here.

The ANOA report describes the overarching framework that is meant to guide Commonwealth-State arrangements in these terms:

Delivery of programs that span Commonwealth, state and territory
jurisdictions has been the subject of recent Council of Australian Government
(COAG) reforms. The reforms aimed to enhance public accountability for
service delivery by clarifying roles and responsibilities between levels of
government and improving collaboration. Rather than dictating how things
should be done, the new framework focuses on the achievement of mutually
agreed outputs and outcomes, providing the states and territories with
increased flexibility in the way they deliver services to the Australian people.

National Partnership Agreements are one element in this. These generally involve:

1. Negotiation between Commonwealth and States of a framework agreement setting out objectives and broad approaches.
2. Development of an agreed implementation plan setting what will be done and how, along with reporting arrangements on progress.
3. Both agreements and implementation plans contain provisions for variation.  

On the surface, this all seems very sensible. However, problems can arise where:

1. The Commonwealth as funder actually dictates the detail of what is to be included in the partnership on a like-it or lump-it basis. The problem is compounded where terms dictated ignore regional diversity, with a one size fits all approach. The only thing that the states can do in these cases is to try to negotiate on points of detail.
2. The Commonwealth essentially dictates what must go into implementation plans. These may include, for example, requirements that require Commonwealth approval of particular and detailed expenditure plans before any action can commence. They may also include a plethora of requirements and sub-objectives.
3. The Commonwealth is inflexible in implementation.

Problems are compounded because all states and territories have their own rules and accountabilities regarding expenditure that must be complied with, including formal legal requirements. These National Partnerships often involve very large sums of money.  The central coordinating agencies in the states and territories are concerned not just with efficiency and probity issues, but also with the management of cash flows.

Very real problems can be created for things such as state budget processes when the timing and scale of payments from the Commonwealth is uncertain. Further, coordinating agencies are concerned about ancillary costs that can arise in implementation that are not covered and which can affect other parts of state budgets.

If we now look at the Northern Territory report into indigenous housing, we find that program delivery there suffered from, among other things, from a multiplicity of sometimes conflicting and unranked objectives with over-complicated decision structures including no less than six decision layers.

Turning to the school building program, the ANAO summarised some of its criticisms this way:

The program design and funding variation process, which is focussed at project/school and ties funding to individual projects within schools, has not allowed the states to manage BER at a program level. The complex and constantly amended funding variation process has not enabled states to readily transfer funds between schools in order to achieve the agreed outcomes. The variation process and adherence to a narrow definition of approved project is considered increased input control, which is at odds with the principles of the IGA (Inter Governmental Agreement) to focus on outcomes.

Without going into the full detail in the report, some of the problems that arose can be summarised this way:

1. The use of bands based on student numbers to determine project size created inequities between schools at the margin (a shift of a few pupils could have dramatic funding impacts), as well as an incentive to manipulate student numbers.
2. The way that funding was announced meant that was meant to be a maximum spend per school actually became a target spend.
3. The requirement that the Commonwealth approve spend on a school-by-school, project-by-project basis, together with over-complicated objectives and reporting requirements, increased administrative load and reduced flexibility. This was further complicated by a ruling that spend below maximum on particular school projects could not be transferred to other projects in the same jurisdiction but must be returned to the Commonwealth. School systems had no flexibility in adjusting spend between schools to achieve maximum value.
4. Conflict arose between the Commonwealth's approach and the centralised approaches to public education in the various states. This was complicated by Commonwealth rules that created tensions between principals and their state employers.
5. Budget confusions arose. In preparing costings, the Commonwealth Finance Department worked on the basis that spend would equal 90% of the maximum per school. This was interpreted by the Department as 90% of schools participating. Since the Department's aim was 100% participation, while the maximum spend had actually become target, it quickly became clear that spend would be greater than budget. This led to financial adjustments, including transfer of funds from social housing, to try to keep spend within aggregate budget approvals.
6. Given the size of the program, variations in Commonwealth payments created cash flow problems in the states. While these were resolved, it cannot have helped state budgeting.
7. In addition to difficulties associated with transfers of money between school projects, initial Commonwealth inflexibility created on-ground difficulties because of varying on-ground conditions. The intent was that all schools and areas should benefit from stimulus spend and in broadly the same time horizon. However, the actual impact of the downturn was quite variable across Australia, while there were also considerable variations in the available supply of skilled labour.
8. Not only were reporting requirements overly complicated, but the data provided inevitable contained so many variations and was based on so many assumptions as to be unusable in measuring progress. 

I said at the outset that the report was unlikely to provide the type of smoking gun desired by the opposition. Despite building delays of the type I forecast at the time, the report concludes that the program did broadly meet the stimulus objectives. Further, in criticising both the Department and other Commonwealth bodies involved, the ANOA explicitly recognised the size of the program and the difficulties involved. The analysis makes it clear that the Department did try within its limits to be flexible and responsive.

  To my mind, and putting aside the inevitable problems always associated with the delivery of such a huge program, the problems that arose were due to the combination of failures in the way the way the program was specified in combination with the broader systemic features such as inflexibility, over-complication, over-specification and over-control that mark the general Rudd Government approach to public policy.

You can see why some of us are so cautious about things such as the Health proposals. Regardless of the general in-principle arguments involved, there has to be a question mark over the likely effectiveness of the proposals in the absence of a change in the Commonwealth Government's approach to public policy and administration.

Puzzles with the Henry Tax Review

You can find the full Henry Report here. The Government's promotional web site here.

At the moment, we are dealing with two very different things. The first is the Henry review itself, the second with things that the Government has accepted, rejected or left up in the air.

With taxation matters, the devil always lies in the detail. You also have to look very carefully at the language involved.

I simply don't have a view on much of this at the moment. My assessment of the Resource Rent tax as proposed strikes me as a bit gimmicky with a complicated and still unknown pattern of winners and losers. Further, I am not sure that the proposed Commonwealth investment of 40% in new mining infrastructure makes a lot of policy sense.

I am sure that details will change as consultation proceeds. I don't think that the use of the Government bond rate as a benchmark from which to calculate "super profits" is in any way sustainable, ignoring risk among other things.

We can be sure that the various interest groups will pick over the entrails. I will read with interest.   

Australian house prices rise further

While there is anecdotal evidence that the boil may be coming off, the rise in house prices in Australia has been quite remarkable by world standards.

This graph from the Australian Bureau Statistics shows the weighted quarterly average increase in house prices in Australia's capital cities.

You can see how prices came of the boil during the global financial crisis, only to start ramping up again. Average weighted prices in the March quarter 2010 were up no less than 20% from 12 months before.

The biggest increase came in Melbourne (27.7%), followed by Sydney (21%).

According to ABS, both the Melbourne and Sydney increases in the most recent quarter came especially at the high end of the marketplace.

ABS does not give non-metropolitan figures. However, while not rigorous, the numbers I have seen suggest significant rises in regional Australia as well.