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Ergas contra Keynes « Previous | |Next »
December 3, 2008

Paul Krugman in the New York Review of Books argues that what the world needs right now is a rescue operation. Circumstances right now are anything but normal. The global credit system is in a state of paralysis, and a global slump is building momentum. To deal with the clear and present danger policymakers around the world need to do two things: get credit flowing again and prop up spending.The latter is good old Keynesian fiscal stimulus.

In an op-ed in The Australian Henry Ergas, the chairman of Concept Economics, argues that trying to spend your way out of recessions is a mug's game:

When the economy slows, government outlays increase due to higher welfare payments while tax revenues diminish. This fiscal weakening cushions the extent and effect of the slow-down. Governments can try to augment this "automatic stabiliser" by a further, discretionary, weakening in their fiscal position, through increased outlays, lower taxes, or both.It is debatable whether such discretionary fiscal policy is desirable. As the eminent macroeconomist John Taylor recently noted, the evidence is mixed as to whether discretionary fiscal stimulus works, and if so, when, how and by how much. But even if it is desirable, the '80s showed that approaches centred on increased outlays can be both ineffectual and inefficient.

Ergas is in favour of allowing the automatic stabilizers of the market to work but is opposed to Krugman's good old Keynesian fiscal stimulus (public spending) to help prevent a weakening economy from sliding into an actual recession.

Ergas' argument that Keyensiaan economic policy approaches that are centred on increased outlays are both ineffectual and inefficient is this:

They are ineffectual because the lags between government spending decisions and ultimate economic impacts are difficult to predict and, at least for some kinds of expenditures, likely to be very long .... Increased social spending has shorter lags, but often reduces incentives to work and save, creating problems for the future ... Increased outlays are additionally likely to be inefficient because the setting of spending priorities is so vulnerable to rent-seeking. As spending increases are targeted to favoured constituencies, a steep deterioration typically occurs in the quality of public expenditure, making the community worse off.

Ergas qualifies his general argument by saying that if a discretionary fiscal stimulus is required (presumably he accepts that it is), then it is consequently far better delivered through general cuts in taxes (ie., moving the tax system towards flatter rates of tax, eliminating distortions at the bottom and the top of the taxable income distribution) than through targeted increases in outlays.

Hasn't the Rudd Government already put tax cuts into place to return the surplus? Why would any more money from extra tax cuts actually be spent in the current circumstances? Secondly, infrastructure spending would mean that something of value (e.g., decent public transport) would be created.

Surely Australia needs now is good investment in public infrastructure in health, education, renewable energy, public transport, water. The lag argument can be countered by saying that it very hard to see any quick economic recovery, unless some unexpected new bubble arises (broadband anyone?) to replace the housing bubble. Secondly, there is no reason why this investment cannot be based on full transparency of cost-benefit evaluations. isn't the problem the criteria for infrastructure project selection.

| Posted by Gary Sauer-Thompson at 5:29 AM | | Comments (7)
Comments

Comments

Thanks for interesting article, Gary.
To someone of my intelligence, quite meaty.
Deals with different issues on different levels; rent seeking ( who is seeking what?? ) the will of government to implement and employ FAIRLY, cost benefit analysis, as with education and health. And against that, in the context of the underlying clash between Hobbesian and Lockean; and Hobbesian/Lockean against social activist values.
How far down the road do we go with "market forces"? The slums of Calcutta or Sudan? Whilst, at the other extreme, bailing out the mortgage belt everytime its dislocation with reality gets it deeper in debt, even at the expense of needed infrastructures? All it does is reinforce the commodification of the electorate and/by creating a dysfunctional economy.
Krugman's problem is getting the richer sectors of the world to look at reality. We have got to stop seeing ourselves- the West- in isolation from everything and everyone else. You can't forever keep feeding the richest, most spoilt and least deserving sections of the world money to waste on junk while the poorer 4/5ths looks on, on a couple of dollars a day or less.
Although Ergas has a point about people getting "with the program", his stuff is evasive ( ie evading the question of distribution of pain ). A hidden Austrian agenda: elitist, coarse and brutal, emanates.
We are caught, either/or, between the nanny and the jackboot.
On the whole I'd favour Krugman, and Rudd style politicians, early in their working out, are the paradigm for his theories.
So far the jury is out, particularly when we conside things like the plantation forests beancounting subsidy the progressive faction of the Nats combined with the Greens to oppose during the week.

I can't fault your logic Gary.

Ergas writes 'the tendency to compare our current situation to the Depression of the '30s is ... misguided and dangerous'. He however compares our current situation to the 1970s, which doesn't seem remotely analagous.

Predictably enough of course he ends up with the generic solution that libertarians pose to any and every economic woe: a big tax cut.

Ken,
I agree. The 1970s did not have a financial crisis that has seen the Republican Bush administration forced to buy into the banks to keep them afloat. Hence the reference back to the Depression, as some sort of signpost to what is happening now. The early 1990s were about a recession and unemployment after the boom in the late1980s. That was the period of Keating's Working Nation.

I cannot see why you cannot have full transparency of cost-benefit evaluations and very explicit criteria for infrastructure project selection.Would the private companies who would be partners in infrastructure development (eg., PP partnerships) be in favour of full transparency of cost-benefit evaluations? Wouldn't we have all that commercial-in-confidence stuff that has underpinned PPP in the past in NSW?

Paul,
I side with Krugman as well. But we are being offered arguments about different policy options to stimulate a stalling economy by Ergas. They are also good arguments --in the sense that they make good points that require a response---better than the ones I've given.

For instance, you could have some very bad infrastructure development sold under the guise of stimulating the economy and creating jobs. NSW comes immediately to mind. Ergas is dead right on this. It has to be taken out of the hands of the politicians.

What didn't happen at CoAG was Rudd Labor committing to a big lift in capital works — action from the Commonwealth to significantly lift its commitment to infrastructure. Silence, even though lots of money was being spent.

Maybe that is good news in a way. Rudd Labor are waiting for the recommendations from Sir Rod Eddington's infrastructure advisory committee before they do anything. That heads off NSW and Victoria playing politics to get commonwealth finance for their favorite infrastructure projects.

Ken,
the financial economists, bankers and policy makers had a strange set of beliefs that looked like faith.

Capital flows had to be unconstrained. Government intervention was bad. Banks should be allowed to fail. Moral hazard was a big danger as insuring markets would encourage excessive risk. Budgets had to be in surplus.

It was like a theology. You either believed the doctrine or you didn't. If the latter, then you were ex-communicated as an economic heretic.

Noticed a critical article concerning the role of Treasury in NSW in stymieing rail transport spending in NSW.
Then there is Eddington and the Victoria of Brumby (was't Paul Eddington the star of Yes Minister?) and just over the last hour the stalling of non CO2 wind technology alternatives on 730 Report.
Are you sure it's
"was"?