Economists may be bad at forecasting - even at foreseeing something as
momentous as the global financial crisis - but that doesn't stop them
arguing about events long after the rest of us have moved on.
That's
good. Economists need to be sure they understand why disasters occurred
so we can avoid repeating mistakes. They need to check the usefulness of
their various models and whether they need modifying.
One thing
that causes these debates to go for so long is that economics -
particularly academic economics - is based more on theories than
evidence. Some theories clash, so empirical evidence ought to be used to
determine which hold water.
But economists aren't true
scientists. They pick the rival theories they like best and become more
attached to them as they get older. They will try to talk their way
around evidence that seems to contradict the predictions of their model.
This
leaves plenty of room for ideology, for individuals to pick those
theories that fit more easily with their political philosophy.
There's
been much mythologising of our experience with the GFC. Many punters'
memory is that we thought there'd be a bad recession, the Rudd
government spent a lot of money, but no recession materialised so the
money was obviously wasted.
This isn't logical. You have to
consider what economists call "the counterfactual": what would have
happened had Kevin Rudd not spent all that money? Maybe it was the
spending that averted the recession.
One Australian newspaper has
worked assiduously to inculcate the memory that pretty much all Rudd's
"fiscal stimulus" spending was wasteful. It went for months reporting
every complaint against the school-building program, while ignoring the
great majority of schools saying they didn't have a problem, then
misrepresented the inquiry findings that the degree of waste was small.
What
got the economy growing again so soon after the big contraction in
gross domestic product in the December quarter of 2008, we were told,
was the return of the resources boom as China's demand for our
commodities ballooned. (This ignores that China's economy was hit for
six by the GFC, but bounced back after it applied massive fiscal
stimulus.)
To bolster the line it was pushing, the paper did much
to publicise the views of Professor Tony Makin, of Griffith University.
Makin adheres to a minority school of thought among macro-economists
that fiscal stimulus never works. He repeated his long-held views when
assessing Rudd's efforts.
Early last month, the Minerals Council
published a monograph it had commissioned from Makin on Australia's
declining competitiveness. Guess what? All the subsequent events have
confirmed the wisdom of his earlier forebodings.
Makin used "the
classic textbook macro-economic model" to argue that, even during
recessions, fiscal policy is ineffective in adding to economic growth in
an open economy with a floating exchange rate because it "crowds out"
net exports (exports minus imports).
Borrowing to cover the extra government spending
tends to push up domestic interest rates, which attracts foreign
capital inflow. This, in turn, pushes up the exchange rate. Then the
higher dollar reduces the price competitiveness of our export and
import-competing industries, thus increasing imports and reducing
exports. Any increase in domestic demand is thus offset by reduced net
external demand.
Next Makin examined the national accounts showing
a strong rebound in growth in the March quarter of 2009 (thus silencing
the two-quarters-of-negative-growth brigade) and found the turnaround
was explained not by increased domestic spending but by an improvement
in net exports.
There you go: proof positive that his long-held
views were spot on. He attacked the claim that the fiscal stimulus saved
200,000 jobs, saying "this assertion is based on spurious Treasury
modelling of the long-run relationship between GDP and employment". He
criticised Treasury's estimates using dubious Keynesian "multipliers" of
the addition to GDP caused by the fiscal stimulus.
Treasury
quickly released a response to Makin's criticism. His theoretical
argument was based on the Mundell-Fleming model (from as long ago as the
early 1960s), which assumes unilateral fiscal action, a high degree of
openness to trade and perfect mobility of financial capital between
countries. (It could have added the assumption that the central bank
controls the supply of money rather than the level of short-term
interest rates, as ours has long done.)
In reality, all the major
economies applied fiscal stimulus in concert, trade accounts for much
less of our GDP than it does for most developed countries, and the
turmoil of the GFC meant capital mobility was far from perfect at the
time (I'd say all the time).
As for his empirical checking,
Makin's use of the national accounts failed to consider the
counterfactual. It's likely imports fell in that March quarter not so
much because the dollar fell heavily (and didn't shoot back up for about
a year, once commodity prices had reversed and were on their way to new
heights) as because the fear unleashed by the GFC prompted people to
postpone planned purchases of imported items. If so, their spending
would also have fallen, offsetting to boost from net exports.
Makin's
claim that Treasury used multiplier estimates that were long-term
rather than short-term is wrong. The whole idea of the stimulus was to
boost spending (and confidence) quickly to counter the collapse in
confidence. Since the spending measures were always intended to be
temporary (and were, despite the mythology) it was always known that the
effect on GDP growth would be negative before long.
The short-term
multipliers Treasury used were based on the conservative end of the
range of estimates calculated for our economy by the International
Monetary Fund and the Organisation for Economic Co-operation and
Development.
Makin is entitled to his opinions, but he's in a
small minority among economists, even the academics. The two
international agencies were full of praise for our fiscal stimulus and
in no doubt about its effectiveness.
