According to data from the World Bank, the trend rate of growth of the world economy from 1960 up to the Global Financial Crisis in 2008 was nearly 4% p.a. Even over the 20 years preceding the GFC (1987 – 2007), the trend rate of growth was in excess of 3% p.a.
Since the GFC, the world economy has been growing at far below trend: less than 2% p.a.
It is tempting to call the present slow economic growth period that the world economy has fallen into “The Great Recession” (echoing the description given to that earlier period of very slow economic growth in the 1930s: “The Great Depression”).
World Gross Capital Formation (including government investment) has fallen from nearly 26% of World GDP in 2007 to just over 24% of GDP in 2015.
Mirroring this global history, Australia’s economic growth rate has fallen from more than 3% p.a. before the GFC, to just over 2% p.a. since then. Private Gross Fixed Capital Formation has fallen from 22.2% of Domestic Final Demand in March 2007 to 18.6% of Domestic Final Demand in March 2017.
South Australia’s private investment has fared worse. South Australia’s Private Gross Fixed Capital Formation fell from 20.7% of State Final Demand in March 2007 to 15.9% of State Final Demand in March 2017. It would have to rise by more than a third if it were to match Australia’s Private Gross Fixed Capital Formation share of Final Demand before the GFC.
The global policy response to the Great Recession has been straight out of the Keynesian play book – cut official interest rates and increase Government spending and deficits. Interest rates in the economically-advanced countries have never been lower in history. Government debt has soared.
But unemployment has increased substantially and private sector wage growth has shrunk to miniscule rates.
Government policy globally has almost certainly ameliorated economic outcomes, but not enough to stop the Great Recession eventuating.
The slow-down in private sector wage growth has meant that income inequality in the rich countries has become more noticeable and less acceptable. Inequality was masked, and/or made more acceptable to many people, while their wages and living standards were rising. Once this stopped, and unemployment grew, reducing inequality in incomes in the rich countries (“fairness”) has become a hot political issue.
Populist political solutions to raise the incomes of people in the bottom two thirds of the income distribution have gained momentum. Since earnings and incomes typically increase with age, proposals to reduce income inequality have appealed particularly to younger adults.
The electoral victory of President Donald Trump in the United States, offering hope to the bottom two thirds of the income distribution, was a populist political response to perceived rising economic unfairness in America.
He promised protectionist trade moves to assist domestic manufacturing, a reduction in the immigration of unskilled people, and a boost to the economy through tax cuts.
Similarly, Brexit offered populist hope to British people in the UK’s regions who saw their manufacturing jobs dwindling and work being taken from them by migrants (mostly from other countries in Europe). The Brexit result was a surprise to people in in the upper third of the income distribution in Britain.
The affluent, unelected, regulation-setting, distant bureaucrats in Brussels were seen by more than half of the electorate as part of the problem, not part of the solution.
Left-wing political figures like Bernie Sanders in America and Jeremy Corbyn in Britain, who used to be regarded as fringe political players, have started to attract major political interest. In Australia, Labor Opposition Leader Bill Shorten is placing a great deal of emphasis on reducing inequality by raising taxes on upper income earners to pay for more public services in health and education, among other things, as well as opposing cuts to Sunday penalty wage rates.
Labor’s political polling has been very strong since its move to the left. In response, the Coalition Government has also tacked to the left. The Coalition’s 2017/18 Budget justly earned the sobriquet “Labor Lite”.
According to OECD (mostly European countries) data, which some say are unreliable, Australian income inequality is middling – more unequal than Sweden, France and Germany, but less unequal than New Zealand, Britain and the US.
There appears to have been some increase in household income inequality here (from very egalitarian levels by world standards) associated with the freeing-up of the economy in the 1980s and ‘90s. But the longitudinal Household Income and Labour Dynamics in Australia survey run by the Melbourne Institute shows a modest reduction in income inequality since the GFC, unlike the pattern in most economically-advanced countries.
In Australia, as elsewhere in the economically-advanced countries, wage growth has fallen to a crawl, particularly in real terms, when increases in the cost of living are taken into account; and unemployment, particularly amongst young workers, has risen significantly.
At the same time, the very low interest rates adopted globally to boost investment have resulted in asset prices increasing substantially – especially house prices, resulting in younger workers finding it increasingly difficult to buy a home, even with the lower mortgage interest rates on offer.
These trends are seen as unfair by the bottom two thirds of the income distribution and especially to young Australians starting out on their earning lives.
What should we do?
Redistribution within a fixed (or falling) national output and income can only be a short-term political fix unless the underlying structural issues that are limiting the rate of economic and income growth are addressed. Such “naked redistribution”, unsupported by measures to increase the rate of economic growth, will fail as a result of the mounting unemployment and capital flight that will ensue.
Such “naked redistribution” could only survive politically by reducing contact with the rest of the world economy; and ultimately, by repressive measures (as we have seen in Stalin’s Russia and Mao’s China).
Hence, the touchstone of an effective redistribution policy is to maintain open contact with the rest of the world: free and open international trade, and high rates of free immigration. Within this framework, bigger tax cuts for businesses and maybe for households (through a cut in the GST) should be considered; as well as cutting business red tape that does not pass cost/benefit tests.
Government spending that does not pass cost/benefit tests should also be cut.
The South Australian Government should adopt this agenda, as should the Commonwealth Government. The State Government’s expenditure package should include a 5% rebate of company tax (paid to the Commonwealth) for all companies with their national headquarters registered in South Australia.
The fiscal upshot of this is that both governments’ deficits may widen (although it is hard to believe that there are not substantial spending efficiencies to be made) and both governments’ debts may increase (which will have to be addressed later by running surpluses resulting from future spending cuts).
But the South Australian Government’s overriding reform target must be to lift private business investment in South Australia by a third. If it can achieve this, the South Australian economy will grow fast, most likely doubling its present rate of growth.
Richard Blandy is an Adjunct Professor of Economics at the University of South Australia, an Emeritus Professor of Economics at Flinders University, and a regular contributor to InDaily.
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