Happy Christmas to all

As I write, my last post was Economic implications of the Australian Government's Nation Building package on 14 December. I have in fact several part completed posts, so don't be surprised if several posts suddenly appear dated prior to this post! Here I am going to take advantage of the Christmas break to complete some writing.

This blog began simply as a way of recording some of the writing that I and other Ndarala colleagues had been doing on management issues. More recently, I have been using it more as a place for discussion on economics related issues.

I have really enjoyed this, although I do not want to lose total sight of the management content. The change in focus has also led to a sharp increase in the number of visitors. This obviously pleases me.

To all my readers of all faiths and none, I wish you a happy and peaceful Christmas.

Economic implications of the Australian Government's Nation Building package

This photo shows coal trains passing in the Hunter Valley.

For the benefit of international readers, the Hunter Valley lies north of Sydney and is one of Australia's major coal provinces. If my memory serves me correctly, it is now the largest coal producing area in the world.

Introduction

On Friday 12 December 2008, the Australian Government announced the latest economic stimulus measure, a $A4.7 billion national building package. I will discuss this in a moment. However, first I wanted to summarise the key steps that the Australian Government has taken so far. I don't know about you, but I am starting to lose track.

To do this, and despite my complaints about dreaded text tables, the following table summarises some of the measures.

Date	Measure	Comment
12 October	Government guarantees all bank deposits plus new international borrowings by Australian banks to preserve liquidity, overcome loss of confidence, protect the bank's international competitive position	Achieved its objective at one level, but also triggered a run on mortgage funds
14 October	$10.4 billion Economic Security Strategy with two key elements, one-off payments to certain social security recipients from 8 December to boost demand plus increased first home buyers' grants for a defined period intended to increase home building over 08-09 and especially 09-10.	With the cheques just going out now, too early to judge impact.
10 November	Green car plan - $6.2 billion plan to make the automotive industry more economically and environmentally sustainable by 2020.	While the Government is now including this in its list of stimulus measures, it actually reflects different policy drivers.
18 November	$300 million to fund immediate new capital spending by local Government, with funds to be committed by end June 2009.	A broad based measure designed to have impact in the second half of 08-09 and 09-10.
29 November	COAG package - $15.1 billion to stimulate the economy and drive significant reform in health, education, housing, business deregulation, and closing the indigenous life expectancy gap. Claimed to create 133,000 jobs.	This measure replaces existing measures and is not all new spend. The economic stimulus component lies in a weighting of spend towards the front end to achieve a stimulus affect.
12 December	$4.7 billion nation building package to fund capital projects and encourage business investment.	This fund includes  a mix of new spend plus planned spend brought forward in time.

Despite the problems I outlined in Australia's economic stimulus packages - the practical difficulties in cranking up spend, and despite too the inevitable degree of double counting and spin in some of the wording, there can be no doubt that the Government is trying to boost economic activity especially in 08-09 and 09-10.

The new measures

Those interested in the detail of the latest measures can find them here. Ministerial statements can be found here and here.

I noted, first, that the Government is including specific job creation estimates for this and previous measures:

• 75,000 jobs through the Economic Security Strategy
• 133,000 jobs through the COAG Package
• plus 32,000 jobs through the latest nation building package.

The Australian workforce is about 11.2 million, so we are looking at projected job creation of a bit over 2 per cent of the current workforce. In theory, this should more or less off-set the economic down turn, if with a lag.

The second thing I noted about the latest measures is that the projected $4.7 billion spend is made up of:

• $2.5 billion in new planned spend plus $2.2 billion in planned spend brought forward. The significance of the second is that the money is already allocated; spend will go up now, down later on.
• $1.5 billion to be spent in the current financial year, $2.7 billion in 09-10, $500 million in 10-11. Again, we have the biggest impact in 09-10. The Government projects that this measure will add between 1/4 and 1/2 per cent to GDP in that year.

  The proposed spend incorporates a number of very different things

Rail: $1.2 billion to fund 17 railway infrastructure projects. Of this, $580 million will be spent on Hunter Valley rail upgrades, increasing coal export capacity from 97 to 200 million tonnes per annum.

I blinked at this, because the big infrastructure bottleneck at the moment is the port itself, with coal ships often lined up waiting. In April 2007, for example, there were no less than 72 coal ships waiting to enter the port. Presumably, this will be sorted out in future spend.

Other rail spend is designed to remove bottlenecks on the major rail trunk routes between capital cities.

Road: $771 million will be invested in road projects, almost completely made up of accelerated spend on existing projects.

Kimberley development: $195 million has been set aside to fund irrigation and social infrastructure around Kununurra in the Kimberleys in WA.

Education infrastructure: $1.6 billion has been set aside for education. Of this, $581 million will go to fund eleven projects put forward by metro universities, with a further $1 billion to fund teaching and learning capital in TAFEs and universities.

In addition to this planned infrastructure spend, there are two further business stimulation measures.

Pay as You Go payments by small businesses for the 08-09 year will be deferred, with a 20 per cent deferral in the payment due for the December quarter. This is essentially a cosmetic measure providing a short term benefit of $440 million.

More importantly, there will a short term investment allowance of 10 per cent on capital investment over $10,000 in tangible depreciating assets by business in the period up to end June 2009. This measure directly targets business investment at an estimated cost to revenue of $1.6 billion. 

Comment

In announcing the new measures, the Government stated that it expected the budget to remain in surplus. We must be getting quite close to the line here, given previous announcements.

The infrastructure announcements strike me as generally sensible because they should yield a direct economic pay-back over and beyond the immediate stimulus effect.

While the part deferral of PAYG payments will yield a short term cash flow benefit, I do not think that this is of any real economic significance. However, the new investment allowance is of more importance.

The problem with this type of measure is that it yields a wind-fall gain to businesses that would have invested anyway. This has to be offset against the gains in investment flowing from the stimulus. That said, the measure does directly target one of the main economic drivers, business investment.

I do not have access to Treasury's econometric model. I would be fascinated to see projections as to how the various bits fit together in economic terms. Without this, it is hard to make sensible judgements as to collective impacts.

In all this, I come back to two key points.

The first is that we remain in a strong position simply because the budget position has been so sound. So long as any Government measures do not create a structural deficit, there remains considerable scope to expand Government spending.

There is no exact science in economic policy in circumstances such as this. To a degree, it comes back to trying things to see what might work.

The second is the continuing importance of the balance of payments. If the stimulatory measures create a serious deficit here, then stimulatory policy will be constrained. Fortunately, and as I argued in Australia's improving trade performance - October 2008 statistics, our position here is quite good.      

Australia's economic stimulus packages - the practical difficulties in cranking up spend

One of the interesting side-effects of the various Rudd Government measures intended to stimulate the economy is the delivery pressures created.

In recent years, Australia's public sector has been under constant pressure to do more with less. Now the funding taps have been turned on, with pressure to spend in the 08-09 and especially 09-10 financial years for counter cyclical purposes.

This pressure flows from Canberra down through the COAG (Council of Australian Governments) process to individual state agencies. Throughout Australia, thousands of public servants are working on spend proposals, negotiating supporting arrangements with the Commonwealth, developing implementation plans.

From a public service perspective, there is a great feeling of liberation to know that you can now do some of those things that were clearly necessary but were simply out of court because of lack of funding. However, there is a very real problem here.

There is absolutely no point in developing plans when you know that those plans cannot be implemented. Here one side-effect of the past budget constraints, the need to do more with less, is that the development pipeline has thinned over time. Now when we want to spend, we are actually starting from scratch in many cases.

Inevitably, there will be some waste. By this I do not mean that project spend itself will be inefficient in a financial sense, although this may occur. Rather, that our lack of forward planning means that we will not get the best results from the spend in a longer term economic sense.       

Australia's improving trade performance - October 2008 statistics

In the midst of all the economic turmoil around us, I have been watching the trade numbers especially closely.

In recent years, the balance on goods and services (what Australia sells internationally less what the country buys) has been negative. This has been funded by private overseas borrowings, creating a channel down which the effects of the US sub-prime crisis flowed.

The most recent trade statistics from the Australian Bureau of Statistics show a very important turn-around in this position. In simple trade terms, the country moved from a net consumer to net saver at just the right time, thus cushioning the effects of the global financial crisis.

We can see this in the table below which shows exports, imports and the balance on goods and services, using seasonally adjusted data. All figures are in $AM.

Like all statistics, care must be exercised in drawing detailed conclusions without discussing the underlying basis of the statistics themselves. However, we draw some general conclusions without getting too bogged down.

Month	Exports	Imports	Balance
2007
August	18,599	-20,488	-1,873
September	17,711	-19,920	-2,209
October	17,248	-20,207	-2,960
November	18,340	-20,563	-2,224
December	18,807	-20,644	-1,838
2008
January	19,476	-21,747	-2,271
February	18,741	-21,766	-3,029
March	19,641	-22,136	-2,495
April	21,628	-21,909	-381
May	22,243	-23,215	-981
June	23,262	-23,039	222
July	23,475	-23,969	-494
August	24,773	-23,447	1,327
September	26,378	-25,123	1,254
October	28,141	-25,189	2,952

Source. Australian Bureau of Statistics International Trade in Goods and Services Australia, October 2008, Catalogue 5368.0 

Looking at the table, you can see the pattern of significant negative balances in the early period. Had we been in this position when the global financial crisis struck, we would have been in a great deal more trouble. Instead, the balance went into surplus at just the time we needed it to do so.

Expressed in Australian dollar terms, we continued to increase imports. However, this was more than offset by increased exports in Australian dollar terms. This meant that in the critical months August through October Australia generated a cumulative surplus of just over $A5.5 billion.

These are Australian dollar figures.

If you look at the September and October figures, you can see a sharp jump in both imports and exports. The Australian dollar depreciated sharply during this period against the US dollar, increasing both export and import prices in local currency terms. This was especially pronounced on the export side since 80% of Australian exports are sold in US dollars.

In effect, the global currency traders who dumped the Australian dollar delivered a net benefit to the country in trade terms. This could have been disastrous had it destroyed the Australian dollar market. As it was, the Australian Reserve Bank was forced to intervene several times, buying Australian dollars to maintain liquidity.

Again, the Bank's ability to do this was enhanced by the improvements in the balance of trade on good and services.           

Shanghai's Bund

End of another month.

The following photo taken while we were in China in September shows the view across the river to Shanghai's Bund. I thought the photo was a good way to end the month because of the importance of China to the global economic outlook.  

Operations of Australia's bank guarantee scheme

I had been wondering how the various elements of the Australian Government's bank guarantee scheme were working in practice after the initial negative fall out in the mortgage funds market. A story by Mathew Drummond in today's Australian Financial Review provides some hints. I cannot give you the full link - the story is behind the FR's pay wall.

As an aside, I have been meaning to do an update on the media and the internet. Just a reminder to myself to do so.

From today, Australian banks will be able to use the Government's guarantee to raise funds off-shore, creating triple A borrowings. In Parliament, Australian Corporate Law Minister Nick Sherry said that sixteen institutions had already advised that they would make use of the new facility. However, Mr Sherry did not know at this point just what sums might be involved.

Mathew Drummond notes that the similar British scheme that has now been in operation for a month has lowered funding costs with quite fine margins because of investor demand.

Also from today, domestic depositors with deposits of more than one million dollars will have to decide whether or not they are prepared to pay the insurance premium required to gain the Government guarantee on their deposits. Apparently only Macquarie Bank is planning to absorb this.

My feeling is that a good number won't bother. It all comes back to a risk assessment.

More broadly, I find it interesting that the heat and worry generated by the global financial crisis itself has, at least so far as Australia is concerned, largely vanished.

The topic is no longer a BBQ stopper, although withdrawals from many mortgage funds remain frozen. People are far more worried about changes to the real economy.

In an earlier post, What is the difference between recession and depression? Saul Eslake's View, I referred to Saul Eslake's discussion on the differences between recession and depression. Australia may avoid technical recession, but to most Australians it certainly feels as though the country is in recession.  

Winton Bates, Jim and the problem of deficits

I had to laugh. One of my old colleagues (old I hasten to add just because I have known him for a long time), Winton Bates, ran a post Can budget deficits cure the debt problem? reporting on a conversation he had had.

Now that conversation captured pretty well some of the things that I have been talking about. I leave it to you to make your own judgements.

Government budget deficits - cyclical versus structural: lessons from the 1970s

There is considerable discussion in Australia at the present time about the Australian Government's apparent reluctance to run a budget deficit. There is also criticism of the Government's apparent desire to still cut costs at a time of downturn. To a degree, the discussion confuses different issues.

The first key thing to note is the difference between cyclical and structural deficits.

In simple terms, a cyclical deficit comes about because revenue rises and falls with changes in economic activity. With given spend, the budget is in surplus at one point, then goes into deficit, then comes back into surplus. This provides a cushioning effect. Counter cyclical spend fits within this definition because it is specifically time limited.

A structural deficit is different. Here changes to the pattern of revenue and expenditure occur such that a deficit appears independent of the level of economic activity, continuing even at times of higher activity.

The 1970s saw the end of the old concept of the welfare state. One reason for this was that Government spending patterns in many countries ended up with specific built in features that ensured growth in spend faster than could be supported by the longer term trends in economic activity. This could not be accommodated through increased taxation, leading to persistent structural deficits. This crowded out private sector activities and helped build in inflation.

We do not want to go there again. So the issue about deficits is not just the immediate impact, but also the nature of the deficits themselves. We need to avoid the creation of structural deficits.

This leads me to my second point.

The need to control spending, to get the best value from Government spend, continues independent of the state of the economic cycle. We need to prune fat just as much during downturns as at other times. More so in fact, because in this type of downturn financial disciplines can easily become relaxed. Further, Government has a continuing need to re-set priorities as needs change

Pruning spend has an economic impact. In times like this, every dollar we save is simply a dollar that we can then spend in another way.

What is the difference between recession and depression? Saul Eslake's View

A post by Saul Eslake, What is the difference between a recession and a depression?, on Club Troppo provides a remarkably interesting discussion on a topic of interest to many at the moment.

Scoping the global downturn - a few numbers

It is very easy to get depressed just at present about the global economic situation, especially if you listen to the news too much. In my economics posts I have tried to educate myself and, hopefully, others about some of the economic parameters involved without getting too caught up in the short term detail.

In this post I want to continue the discussion by focusing on a few macro numbers.

The table below sets out 2007 GDP for the top twenty global economies. Between them, they amount to a bit over 81 per cent of global GDP.

First the bad news.

If you look at the relative size of the economies that are either in or likely to enter recession, you can see why the world has an economic problem. In simple back of envelope terms, with countries controlling over 55 per cent of the global economy entering recession, the remaining 45 per cent must inevitably be affected.

The numbers also show why a degree of caution needs to be exercised in talking about the role of countries such as China or India. The US economy is presently a bit over four time the size of China's, so every one per cent fall in US GDP requires a four per cent increase in China's GDP to maintain the economic status quo. 

The figures also indicate the size of the tectonic shift now underway in the global economy.

At present, India and China between them are a bit under one third the size of the US economy. If, as seems possible, the US records average zero growth over the next three years while India and China average 8 per cent over the same period, then (assuming my rough maths is correct), the combined India/China GDP will rise to around 41 per cent of the US total in just three years.    

Table: World GDP 2007

Country	Rank	GDP (millions $US)	% World
World		54,347,038
US	1	13,811,200	25.41
Japan	2	4,376,705	8.05
Germany	3	3,297,233	6.07
China	4	3,280,053	6.05
United Kingdom	5	2,727,806	5.02
France	6	2,562,288	4.71
Italy	7	2,107,481	3.88
Spain	8	1,429,226	2.63
Canada	9	1,326,376	2.44
Brazil	10	1,314,170	2.42
Russia	11	1,291,011	2.38
India	12	1,170,968	2.15
Korea, Rep	13	969,795	1.78
Mexico	14	893,364	1.64
Australia	15	821,716	1.51
Netherlands	16	754,203	1.39
Turkey	17	657,091	1.21
Belgium	18	448,560	0.83
Sweden	19	444,443	0.82
Indonesia	20	432,817	0.80
Top 20		44,116,506	81.12

Source: World Bank

Now for the good news, the reason why I remain optimistic, especially so far as Australia is concerned.

Major developed countries are going to have a nasty downturn whether we like it or not. This is already flowing onto other countries including China where unemployment appears to have risen sharply as a consequence of the downturn in manufactured exports.

In some ways the global financial system is awash with liquidity. However, and putting the financial crisis itself aside for the present, this will not translate into extra activity because people (consumers and business) are reluctant to borrow unless really forced to and then banks are reluctant to lend.

Most governments are putting old fashioned pump priming measures in place intended to stimulate consumption and investment. These will take time to come into effect. Further, the initial effects will be muted because some of the initial spend is likely to flow into savings and debt reduction. People just don't want to spend when things are so uncertain.

To my mind, the big kicker will come as increased government investment spending kicks in. This will vary from country to country, but in all cases will take time. With exceptions such as China which already has projects in the pipeline, governments will have to create project pipelines. From experience, it is likely to be eighteen months before spend accelerates in most countries.

Note that I have said nothing about confidence effects. My personal view is that there may well be more shocks and that, in any event, pessimism is likely to remain dominant until things have clearly started to improve.

Pulling all this together, my best guess is that we are going to see a deepening recession in most major industrial countries over the next twelve months. I do not see how this can be avoided, although the effects are going to vary from country to country.

Beyond this point, I would expect to see progressive strengthening in global economic activity as further investment spend kicks in. This is based just on mechanical economics 101 style analysis.

I really can't see in all this just how a depression might occur in global terms, barring some total catastrophic collapse. My bigger worry is the likelihood that the combined total of Government responses will over-shoot, creating a new set of problems on the other side.

Finishing with a note on Australia.

It would be a brave person who would say categorically that Australia can avoid recession. However, whichever way I look at the numbers, I think that we can say that Australia is better positioned than most to avoid a serious downturn .

We are also better positioned than most to benefit from increased investment spend since we are a key supplier of the commodity products that will be required as inputs into new infrastructure.

To the degree my overall analysis is right, then we are likely to see strengthening export demand twelve to eighteen months out.