I do not expect the Reserve Bank to cut interest rates today. Nor should it.
This is no automatic opinion of an inflation hawk. Rather it is the view of someone who has considered and rejected the views of those proposing further rate cuts now.
The strongest view is that the immensely strong mining boom is sucking strength from other industries both by its direct demand for resources and its indirect effects due to higher interest rates and a higher exchange rate. In particular, manufacturing, tourism and education are all suffering from these indirect effects, and if these industries are to play an important role in Australia’s future, rate cuts would reduce these side effects and allow for more balanced economic development.
This is a key argument and deserves careful public debate. Henry debated this argument at length with Mrs Thornton on a long car journey over the weekend. She reminded Henry of the economist’s mantra, the theory of ‘comparative advantage’, or ‘do what you are good at’. What a nation is good at is not, sadly, what it is a bit above average at. To qualify as an important part of a nation’s economic future in the modern world of largely free trade and open borders , it must focus on what it is world’s best at doing.
Mining, agriculture and sport are the three industries at which Australians are clearly world beaters. Fortunately all three look like being highly successful industries for the foreseeable future. Mining will provide resources for the development of emerging economies of China and India, and many smaller emerging economies. A world of seven billion people rising to nine or ten billion with its middle classes rising even faster is a world desperate for large quantities of high quality food.
Sport speaks for itself, and will be showcased at the forthcoming London Olympics. Global sport is rapidly becoming big business, and Australia would be wise to invest strongly in this business.
If forced to nominate another industry for special attention I would nominate medicine. The world of nine or ten billion older, wealthier people will be a world of greatly increased demand for medical services. Australia has world leading medical science and equally fine standards of medical treatment. We would be wise to encourage medical science with far larger grants to medical scientists and facilitate the development of a new export industry to treat Asia’s wealthiest aging people. I have no doubt that money spent in this way would repay Australian taxpayers far more handsomely than handouts to car manufacturers.
Another argument is that Australian consumers have begun to save after decades of enthusiastic spending. Reducing interest rates will restore spending, and protect and enhance the profits of retailers. But Australian’s have again begun to save because they recognise that saving will increase their families’ independence in an uncertain world. Furthermore, saving more now will enable people’s consumption to grow faster when they are older, which will allow for a more even spread of lifetime consumption. Translated to the macroeconomic sphere, Australians saving more will allow the nation to grow faster by investing more of its own money funding the mining, agricultural, sporting and medical booms that will define our successful future.
A prominent economist, Ed Shann, last week in The Australian, found unconvincing Glenn Stevens' argument that annual growth is (or 'ought be') set to be at the trend rate of around 3 %. Growth above this rate (without inflation) is possible, argued Shann, for three reasons.
The current mining boom 'is large and sustained'. Mining investment is massive and will raise the capital stock faster than trend, increase productivity and therefore allow faster than trend growth without inflation.
While unemployment (as measured by the ABS and paraded by government) is low, there is substantial underemployment, with many people wanting to work longer hours. The participation rate has been falling, thus preventing unemployment rising more.
Skill shortages are frequently seen as a barrier to faster growth. But, says Shann, 'skill shortages and regional labour market pressures can be addressed by increases in skilled immigration, accelerated training and more fly-in, fly-out workforces. There is no evidence as yet of shortages of skilled labour in mining flowing into general wage claims elsewhere. Government policies can help, but we must be able to have faster aggregate jobs growth than now'.
In summary: 'Underlying inflation has slowed. That suggests output can grow faster without inflation problems. The debate should be over whether output can only grow at the trend rate, or faster than that'.
This argument I would find convincing if I were convinced that inflation really is under control and that wage demands would remain moderate in the face of the great acceleration of mining investment and the introduction of the carbon tax, a curious mixture of a high cost to producers and blatant over-compensation of consumers.
There is the additional argument that the foreshadowed swing from large deficit to (tiny) surplus makes room for further rate cuts. If the Gillard government was set to produce a genuine and sizable structural surplus this might be a good argument, although even in that (implausible) case I would argue that the Reserve Bank should await the actual budget before rewarding us all with another rate cut.
I have no doubt that many people are doing it tough. I would note that tough times make, or should make, for powerful responses. The Rudd-Gillard government has produced no powerful or convincing responses.
It failed to produce a vision for Australia that focuses on what is needed for success in the modern world, or policies to implement such a vision. It is privately supportive of consumerism as the doctrine of the modern working-person’s Labor party, ‘a flat-screen television in every lounge room’. And its ‘stimulus’ package in response to the Global Financial Crisis was itself wasteful and boosted Australia’s by no means trivial total debt. Equally important, this also sent the wrong messages to the people of Australia, who have themselves adopted a more frugal set of wealth management standards.
I expect Glenn Stevens to ignore the siren calls of the arguments for rate cuts now. If inflation remains low, and wage claims also, the Reserve may make a token further rate cut in response to a responsible budget in May.
Published today in The Australian.
If government decided it was vital to support strategic manufacturing, here is a description of what could sensibly be done.
The alleged 'paradox of thrift' is refuted here.
Australia's poor recent productivity performance is discussed here.
Here is Ed Shann's case for cutting interest rates.