Home > Economic policy, Economics - General > Lowering the NAIRU

Lowering the NAIRU

February 19th, 2008

Among the relatively few points the opposition has scored in this Parliament has involved the unwillingness (or, in the Opposition’s telling, inability) of Treasurer Wayne Swan to respond substantively to a question from Malcolm Turnbull about the level of the NAIRU (non-accelerating inflation rate of unemployment), AKA “the concept formerly known as the natural rate”.

At this point I was going to refer readers to Wikipedia but, as with quite a few economics articles, it’s not entirely satisfactory. However, rather than complain, I’ve edited it to include a slightly better explanation.

Coming back to Australia, the fact that inflation is rising suggests that, if the NAIRU exists, we are now below it. It doesn’t seem as if there is much scope for fiscal and monetary policy to be tightened further. Given the risk of a breakdown in global credit markets, raising interest rates any further seems very dangerous. And the tax cut promises (which should be kept – the credibility of political processes is more important than the risk of inflation) mean that the scope to tighten fiscal policy is limited.

What remains is the possibility of reducing the NAIRU by improving the performance of labour markets. Education and training will help in the long term, but not so much in the short run. What is needed is to take advantage of the tight labour market to reduce long-term unemployment and to bring discouraged workers back into the labour market. At this phase of the cycle, the best policy instrument to achieve this goal is a targeted wage subsidy. Employers who take on workers moving off unemployment and disability benefits, or re-entering the labour force after a long absence should receive a subsidy for a period of say, three to six months. I’ll try to post a bit more on this, and why it’s superior to suggested alternatives like cutting minimum wages, before too long.

  1. February 20th, 2008 at 23:22 | #1

    Terje, I believe foriegn nations subsidise their producers because it’s smart.

    It seems we disagree.

  2. Ian Gould
    February 21st, 2008 at 00:59 | #2

    Salient: “Terje, I believe foriegn nations subsidise their producers because it’s smart.”

    Salient, if you’re a regular reader here you know how rare it is for me to agree with Terje.

    I hate to resort to the appeal to authority but it’s as near to a universally accepted proven fact as you’re ever likely to get in the social sciences that free trade increases incomes for all participants and that the countries with the lower wages pre-trade liberalisation gain the most from free trade.

    Protection doesn’t make countries richer, it makes some groups within countries richer at the expense of the majority of their fellow citizens.

  3. Ian Gould
    February 21st, 2008 at 01:04 | #3

    “In comparison with the rest of the world, Australia is employing free trade ideology to protect its big business exporters at the expense of the enterprises which supply the domestic market.”

    Spend five minuters on google, look for statistics on “effective net levels of protection”.

    Australia is nowhere near the country with the lowest levels of protection, we’re somewhere in the middle.

    Oh and since Gough Whitlam started the process of cutting protection (a fact most commentators on both the right and left prefer to ignore) Australian living standards have risen significantly.

  4. Ian Gould
    February 21st, 2008 at 01:12 | #4

    “Also, just because LKY is a politically incorrect loudmouth doesn’t necessarily make him wrong.” – Conrad

    No, being a corrupt brutal dictator (who happens to have run a relatively successful economic policy) makes his judgment, if not wrong highly suspect.

    I get exasperated with leftwingers who think Cuba’s health services excuse Castro’s prison camps. I get equally exaspated with peopel who think Singapore’s economic growth excuses Lee Kwan Yu’s election rigging and political intimidation. (The world’s longest-imprisoned politcial prisoner is in Singapore.)

    Lee Kwan Yu may or may not be a racist. But over the past 50-odd years, he has proven himself extremely effective at manipulating and inflaming racist sentiment amongst the ethnic Chinese majority in Singapore in order to maintain his power.

  5. wizofaus
    February 21st, 2008 at 05:41 | #5

    Terje – we do gain by reciprocating, it’s called the “tit-for-tat” strategy.

    Let’s say we sell beef to the US and they sell cars here, with no tariffs.
    The US then puts a tariff on beef imports because they can see that their local producers aren’t competitive with Australian imported beef.
    Australia is now losing out on beef export income, has a negative balance of trade, so decides the only option is to reduce the importing of cars from the US. Easiest way to do that is to put a tariff on those imports.
    Now both countries have lost out – they’ve reduced the amount of trade – but at least they’ve lost out evenly.

  6. February 21st, 2008 at 08:37 | #6

    Wizofaus,

    Tit for tat can be a good strategy when there are two players. However if an aussie beef farmer sells to a US consumer and the government of either country weighs in this is not a tit for tat strategy. Trade is not between nations but between producers within nations. Governments can interfere but they are not enabling a better trade outcome.

  7. Salient Green
    February 21st, 2008 at 08:39 | #7

    Ian Gould, as an average, Australian living standards would have risen significantly without Gough Whitlam starting the process of cutting protection, as they have for most of this century.
    In the real world, we need to ask the people here who lost their good manufacturing jobs with the interesting technical work, career paths and job satisfaction, and are now working in a dumbed down position in an abbatoir or warehouse, or are travelling 500 to 1000km a week to stay in more satisfactory work, if they really believe their living standards have improved.
    I dont need to ask my fellow horticultuists. The vast majority, who were never wealthy to begin with, would say their living standards have declined. Same for the pork and lamb producers, and dairy farmers. Ask the Mitsubishi workers and the component manufacturers.
    In my world, free trade is making some groups richer- mining, retail- at the expense of the majority of citizens, who have actually had to work harder to achieve better living standards.

  8. Salient Green
    February 21st, 2008 at 08:55 | #8

    Much of world trade has become trade for trade’s sake. What is the point of Australia selling a $1m of beef to USA which produces enough of their own, only to give that money right back again to pay for cars we don’t need. If you total up the administration, and transport costs, without even the global ecological costs, there is a net loss. It’s make work.
    Now if Australia made a really good combined heat and power solar system, and traded that with USA’s really good lithium batteries, that would make sense.
    And we may have free trade with USA but we don’t have fair trade.

  9. derrida derider
    February 21st, 2008 at 09:03 | #9

    On the NAIRU, people should be aware that the NAIRU framework is controversial these days. The trouble is that the NAIRU is very moveable – at any given time estimates of it seem to rather closely correlate with what the actual rate of unemployment was a couple of years ago. This renders it problematic as a guide to policy.

    If anyone thinks this is a purely academic point, they should note that Treasury’s chronic underestimate of tax revenue in its forecasts of recent years (with consequent massive missed opportunities for structural reform) have a lot to do with the use of a model that keeps pulling the long term rate of unemployment back to a fixed NAIRU estimate that is always behind the game. And I also think it might have made us miss an opportunity to make the early 90s recession a short (if intense) one – like the US one – without the overhang in the Australian labour market that bedevilled the 90s.

  10. February 21st, 2008 at 09:08 | #10

    In the real world, we need to ask the people here who lost their good manufacturing jobs with the interesting technical work, career paths and job satisfaction, and are now working in a dumbed down position in an abbatoir or warehouse, or are travelling 500 to 1000km a week to stay in more satisfactory work, if they really believe their living standards have improved.

    Yes lets survey all the sad disappointed people to see if people are sad and disappointed. That sounds reasonable. ;-)

  11. February 21st, 2008 at 09:16 | #11

    On the NAIRU, people should be aware that the NAIRU framework is controversial these days.

    The NAIRU is the son of the Phillips curve. Hopefully they will one day be buried together.

    There is no reason that you can’t have actual deflation and full employment. The idea that declining unemployment causes inflation is daft. Inflation and deflation are monetary phenomena. Unemployment is a product of price regulation and poor incentive.

  12. derrida derider
    February 21st, 2008 at 09:33 | #12

    Salient Green’s memory is affected by nostalgia. I grew up in a horticultural district in the 60s, and in that golden age there was real poverty amongst the ‘blockies’, at a level unknown today. They generally didn’t have such luxuries as a fridge or a car (I leave you to imagine what that meant for a farming lifestyle)or often even electricity. Their seasonal harvest workers were even worse off – I knew kids who suffered obvious malnutrition, and not all of them were aboriginal.

    Real wages today in those “dumbed down positions” are over 40% higher than in Whitlam’s day while the average hours worked are shorter. A bigger proportion of the population are in paid work now than ever before in our history, largely because wages are high enough to make working in such jobs more attractive than staying at home. Far from the pcture of people being deskilled that Salient paints, more of the workforce than ever before are in skilled jobs (which is of course a part of the reason wages are so much higher now than they were).

    Now not all of this progress is due to freer trade, but I’d suggest that the picture is inconsistent with freer trade actually harming living standards.

    As a BTW, Salient, do you export any of your production? You do realise, I hope, that if we protect firms like Mitsubishi then exporters are the first to pay the costs of it in the form of a higher dollar (ie lower prices for your output) and increased input costs?

  13. conrad
    February 21st, 2008 at 10:22 | #13

    Ian,

    there is no comparison between Singapore and Cuba. In terms of human rights abuses in the last 50 years, Singapore and Australia is a better comparison — especially if you include things that seem to slip many Australian’s abuse radars, like trying to wipe Iraq off the map twice, waiting until 2008 to say sorry for genocide (yet still not admitting liability) etc. . Simply because English speaking whites don’t happen to see these as particularily bad doesn’t mean that the rest of the world doesn’t. I’d rather suffer a bit oppresion/corruption from my own government than be wiped off the map by someone elses. Surely the second of these is a worse human rights abuse.

    Also you keep complaining about LKY being racist. I’m sorry to say Ian, but the reason the Chinese don’t get along with the Malays is not because of LKY at all (the problem is much older), its because the Malays essentially had (and still have) a fascist state designed to oppress the Chinese (and Indians for that matter). If Australia had rules like Malaysia, we’d get sanctioned for racism by other countries (lets have “whites only” universities, for example). LKY should be seen as hero of the Chinese people (as the Chinese government already sees him incidentally), for helping millions of Chinese escape from a fascist Malay government and then helping to build one of the best countries on Earth.

  14. Salient Green
    February 21st, 2008 at 10:29 | #14

    derrida derider, I appreciate yours and all the others’ efforts in continuing this discussion.
    There were times past of severe over-production which led to poverty but that is not the case now. I have been in horticulture since 1980 and in manufacturing, off and on, since 1972. Both have been in decline since the early 90′s. The current affairs programs regularly try to inform people of the real cost of free markets. Dick Smith tried to address the problem. I am trying, in my way, to inform and change perceptions. Even the new Labour government recognises the problem of what we do after the mining boom with so many jobs lost to China and India. Are you all econmists? Is that why my experiences are opposed? Even my friends and family who are doing well in service jobs, with investment properties and huge superannuation realise this is not a good situation because it’s not sustainable.

    The dollar has been very low and recently very high, completely indepent of continuing liberalising of markets and reductions in assistance.

  15. February 21st, 2008 at 13:06 | #15

    SG,

    If you have a concern about monetary policy then join the club. The Australian dollar is a monopoly product produced by a single supplier and enforced by government laws. People can argue the merit of fiat currencies or question the viability of the free market alternatives we once used, but fiat currencies don’t represent free markets. If our currency moves up or down in a destructive way look no further than the government sanctioned, monopoly supplier called the central bank.

    Regards,
    Terje.

  16. Salient Green
    February 21st, 2008 at 13:48 | #16

    Terje, yes monetary policy is another one of those too-low kicks, but different to free trade kicks.
    DD seemed to be telling me that free trade is good for my business because protectionist policies were bad because they caused the dollar to rise. I don’t buy it. There is some pretty perverse logic in economics but I don’t see that connection.

  17. rossco
    February 21st, 2008 at 14:31 | #17

    There is little point in talking about tariffs when we have a floating exchange rate. Movements in the exhange rate up or down have immediate effects on the cost of imports or the earnings on exports. So perhaps salient green might like to consider whether it is floating $A which has killed his local manufacturing as well as his horticulture. I don’t know the answer but just throw it into the mix for discussion.

  18. Ian Gould
    February 21st, 2008 at 14:52 | #18

    “there is no comparison between Singapore and Cuba. In terms of human rights abuses in the last 50 years, Singapore and Australia is a better comparison”

    Well sure if you ignore things like shooting political protesters dead in the streets and detention without trial.

  19. Ian Gould
    February 21st, 2008 at 14:59 | #19

    “Also you keep complaining about LKY being racist. I’m sorry to say Ian, but the reason the Chinese don’t get along with the Malays is not because of LKY at all (the problem is much older), its because the Malays essentially had (and still have) a fascist state designed to oppress the Chinese (and Indians for that matter).”

    No actually it’s because back in the 1940′s the Malayan Anti-Japanese Army was overwhelmingly made up of ethnic Chinese (largely because of the behaviour of the Japanese in China).

    At the end of World WAr II, the Malayan Anti-Japanese Army changed their name to the Malayan Communist Party and took it upon themselves to execute thousands of “collaborators” who just happened to be overwhelmingly Malays.

    “If Australia had rules like Malaysia, we’d get sanctioned for racism by other countries (lets have “whites onlyâ€? universities, for example). LKY should be seen as hero of the Chinese people (as the Chinese government already sees him incidentally), for helping millions of Chinese escape from a fascist Malay government and then helping to build one of the best countries on Earth.”

    Singapore practices equal or more severe discrimination against their Malay and Indian citizens.

    They just hide it better.

  20. Fred Argy
    February 21st, 2008 at 14:59 | #20

    John, the debate is very interesting and so are the various proposed solutions. But solutions to what?? Are we trying to address a phantom problem?

    How (through what channels) is our current low unemployment rate intensifying inflation? In the original Phillips Curve analysis, it was supposed to create structural labour shortages and push up nominal wages but while wages are rising faster in WA and Queensland, the overall wage picture is fairly benign. Wage inflation alone cannot explain the marked acceleration in underlying inflation. Reading the RBA, it seems more worried about rising inflation expectations. But while inflation expectations are rising, the mechanism by which this affects wages in a low-unionized and decentralized wage bargaining system is far from clear.

    This raises the ugly possibility that the recent acceleration in underlying inflation may be the INDIRECT result of higher energy and food prices. While the RBA measure discounts for these volatile items it does not exclude the indirect effects.

    So could it be that we have a world-wide “cost-push� inflation scenario rather than domestic demand pull? If so, dampening aggregate demand will not help much to relieve underlying inflation. It will lead us straight into stagflation.

    Perhaps it might be better to simply accept a temporary increase in inflation to 3-4% (the RBA’s target indicator is a medium term average) until the cost pressures subside. In the interim Harper may help by recommending a low minimum wage increase.

  21. Ian Gould
    February 21st, 2008 at 16:08 | #21

    To broaden the original topic slightly, there are a number of things which the Australian government could do which would make life much easier for new businesses and the self-employed which would reduce business costs, increase the productive capacity of the economy and make it easier for new businesses to start up.

    For starters, the income threshold for compulsory GST registration should be raised from $50,000 to something like $500,000 (I believe the UK figure is even higher).

    Businesses not registered for GST still pay GST on their purchases but can’t claim credit for such payments. Small businesses typically pay very little GST but spend relatively large amounts on compliance costs. The cost to business is probably
    several dollars for every dollar of tax revenue.

    Secondly, Australia could follow the example of the UK and set a lower rate of corporate tax on the first $20,000 or $30,000 of company income. This would cost relatively little but make it much easier for small business to expand.

    Finally, the Australian government should take a really hard look at the US Small Business Administration which has helped millions of small businesses to set up and expand.

    (Unlike similar Australian schemes, the SBA doesn’t make loans or grants. It guarantees loans from private lending institutions in exchange for a fee. The SBA actually makes a profit.)

  22. February 21st, 2008 at 16:49 | #22

    Fred,

    Higher energy and food prices are a product of this inflation cycle not a cause. Commodities such as gold that have little utility beyond monetary are also sky high. This is in spite of the IMF talk of gold sales. It is as it was in the early 1970s. Gold up, then oil then other commodities then wages and consumer goods. Unless the monetary authorities remove the sourse of the problem then we are going to have full flight inflation. They have been caught napping, particularily in the US.

  23. Salient Green
    February 21st, 2008 at 18:04 | #23

    Fred, on the cost push side, you can add the hike in iron ore price, and the cost of steel due to China closing some of its mills.

    Terje, could it be that Australia is suffering from cost push inflation caused by China’s demand pull inflation. We are told that Australians are buying too many plasmas and SUV’s but when you look at rising oil, fertiliser and steel prices plus the shortage of fresh food, makes one wonder.

    Rossco, certainly in the last few years, the high dollar has hurt, and the extra buying power has been negated by rises in said commodities. I can’t remember a significant reprieve when the dollar was low and the wine boom was happening then which could have occurred at todays dollar value.

  24. Ikonoclast
    February 21st, 2008 at 21:03 | #24

    I am glad to see that our host answered the first question that came into my mind about the NAIRU.

    My question was going to be “Is it real?” My great suspicion was that it was not real. Thanks JQ for comfirming that.

    I think in general that theories like the NAIRU are created when people are trying to fit reality to a pet theory. They are forgetting the first rule of empiricism. An hypothesis must be tested against reality and if it does not fit it must be discarded.

  25. February 21st, 2008 at 21:30 | #25

    SG,

    Growth in China is nothing new although it is obviously compounding. Inflation is a monetary phenomena not something caused by economic growth. In fact in a closed economy with a fixed money supply economic growth is deflationary. And only a couple of years ago China was growing at nearly 10% whilst undergoing consumer price deflation. Historically we can also look to the period 1800 to 1900 in the UK where the industrial revolution was in full swing and the economy was booming. During that century the price level halved suggesting an average inflation rate of -1% per annum. Economic growth does not cause inflation.

    None of this is very new. Pick up a history book. We have been here before. Again and again and again.

  26. Ikonoclast
    February 21st, 2008 at 21:48 | #26

    Confucious says: When a mouse grows at 10% per annum indefinitely, your children will have an elephant in the house. When that elephant grows at 10% per annum indefinitely, your grand-children will have no house.

  27. Jill Rush
    February 21st, 2008 at 22:47 | #27

    Wage subsidies have been used very effectively in the past and the Job Network can still use this method. The reason that it went out of fashion is that it eats into the bottom line.

    The Job Network has payment parameters which operate against meaningful training and wage subsidies. It is one of the reasons that we have skills shortages as employers have been reluctant to train and employees are often too insecure, poor or uneducated to pay for their own.

  28. E.D.
    February 22nd, 2008 at 22:42 | #28

    Granted that some (many?) long term unemployed end up on DSP. Nonetheless, ABS statistics show that long-term unemployment and very long term unemployment has been consistently falling for the past 14 years. There were no wage subsidies for most of that period.

    If it wasn’t needed then, surely it isnt needed now.

  29. February 24th, 2008 at 17:26 | #29

    So much has been written on this thread that it has taken me this long to compile a compendium answer addressing matters arising. I only hope that things haven’t gone stale in the interim. This mostly follows particular comments:-

    Terje commenting at 6, the Swales method achieves the effect of relaxing minimum wages by still delivering them while getting rid of their marginal cost to employers. It’s not a true subsidy since there is no funds outflow, unlike other similar suggestions.

    Mugwump commenting at 7, Ian Gould’s point commenting at 8 is partly right, since negative income tax does have a large funds outflow until wages paid adjust downwards enough for enough people to price themselves into work (after which tax revenues go up to cover the outflow). Basic Income/Citizens’ Dividend schemes are even worse that way (this is the problem with the suggestions of Terje commenting at 34). However, they are all long run equivalent to the Swales method, particularly if that is implemented with anonymous transferrable vouchers since those will eventually get monetised. Ian Gould is missing it when he says “how about how the whole point of the proposal is to increase the labor force by encouraging employers to give the long-term unemployed a go?”, because a broad based system reaches those too; targetting is what makes schemes like this fail, because it mostly just moves unemployment from one group to another (I won’t go into the games theory behind this).

    Uncle Milton commenting at 12, you are almost right about the lack of skills stopping employers hiring the long term unemployed anyway, subsidy or no subsidy. However, broad based continuing schemes make it cost effective to take them on and train them, plus they plug the leaks that keep topping up the pool of unemployed, which means that new opportunities do go to the existing pool – there is a cumulative improvement. This may be what Salient Green commenting at 15 has in mind.

    Hc commenting at 17, there is a problem with “…the correct logic of [JQ's] position. Abolish all minimum wages, fair pay commissions, the lot and allow markets to determine wages for all. Then boost those wages using transfers for all those society believes are underpaid.” It’s from the sequence and the time lags. Between doing that and improvements coming in, you don’t just have large funds outflows with no matching tax revenue gains, you get a lot of human suffering. It’s like releasing a tourniquet before you solve the underlying problem the tourniquet bought time for.

    Ernestine Gross commenting at 23, with all due respect, you are mistaken in thinking that “It is exactly the targeting of specific actual and possibly short-term problems that is called for”. That approach stops certain immediate symptoms but rearranges and perpetuates underlying stuff. That is the tourniquet difficulty; but we have tourniquets in place now. Kim Swales’s modelling (op cit) has shown how the broad based continuing approach applies to a wide range of economic conditions, and typically boosts GDP by about half the proportional increase in employment.

    Backroom Girl commenting at 29, you are right in thinking that “…employers aren’t really interested in them unless they are broadly enough targeted to enable them to employ someone they would consider employing anyway”, but wrong in thinking that “the problem with wage subsidies that they are only really cost-effective if they can be fairly closely targetted to people with a low probability of otherwise getting a job…” [emphasis added]. They are only cheap enough that way, but they are actually less cost-effective because they are not very effective. As I repeat, the Swales tax break approach is not a true subsidy and costs nothing (what happens is, tax revenue falls as the unemployed numbers fall – but Social Security outgoings fall in step, budget neutrality not revenue neutrality). This also covers the objections of Bring Back CL’s blog commenting at 32.

    Terje commenting at 34, you are right about how to address inflation. However, the employment connection still matters. Since the subsidy approach is a more or less independent policy option, using it frees up more of the economic levers to get at inflation.

    Salient Green commenting at 43, you have put your finger on something the Swales approach does not address – how to stop economic activity from moving completely out from under the tax base anyway? Well, the long term answer involves changing the corporation tax approach to one getting revenue from shares, so the revenue keeps coming in anyway, and making certain other tax reforms I have neither time nor space to go into. However, there are serious political problems with that, stemming from sovereign risk (i.e., you can’t trust politicians not to change the rules on you). We would have to make constitutional changes to keep them honest.

    Terje commenting at 45 (and commenting at 48), you are wrong about “their loss is our gain” in “If foreign nations wish to subsidise their producers then it is certainly stupid and it isn’t free trade but their loss is our gain”, in a couple of important ways. You are using some aggregate “we”, and there are actually some real forms of damage that can be done that way, even in aggregate, notably by damaging going concerns, effectively throwing away the investment represented by the fact that they are going concerns and not merely a collection of passive assets. That’s why it’s a bad idea to close down less profitable mines when slightly better opportunities are found, say.

    Ian Gould commenting at 52, it’s true but misleading to say “it’s as near to a universally accepted proven fact as you’re ever likely to get in the social sciences that free trade increases incomes for all participants and that the countries with the lower wages pre-trade liberalisation gain the most from free trade”; “all participants” actually means all countries taken as a whole, not all economic players. Furthermore, many things are deliberately misclassified as “free trade” when they are no such thing, and actually harm those on the receiving end – notably “capital transfers” into countries that are wholly or mainly fiat currency flows actually represent the mobilisation of local resources, not any inwards flow of physical capital, yet they must be serviced just the same. But we are getting off topic.

    Derrida derider commenting at 62, you shouldn’t dismiss Salient Green’s account like that; you are distorting the data to fit your theory, in what sounds very like accusing him of false consciousness. Rebut him or bring in other data, don’t “correct” him.

    Fred Argy commenting at 70 brings in points that are important, but different from the topic. The point of connection is that addresing unemployment separately allows a freer hand in addressing these things. (Fred Argy had a letter on these matters in the Australian Financial Review of 22.2.08; I submitted a follow up, which I am pasting in at the end in case it doesn’t get printed.)

    Jill Rush commenting at 77, I’ve covered the costs of subsidy approaches and the training issues further up.

    E.D. commenting at 78, “If it wasn’t needed then, surely it isnt needed now” is the “syphilis goes away” approach. It was needed, we just didn’t have it, and this isn’t an either/or thing anyway – we can do these subsidy approaches as well as anything else that we did that worked, or as well as any outside good luck that might bail us out.

    Here is the body of a letter on this area I have just sent to the Australian Financial Review:-

    Fred Argy states that while many economists have worked on ways of attacking unemployment while keeping inflation from rising, few have found fast working ways.

    One of those who has is Professor Kim Swales of the University of Strathclyde. Where the “five economists’ plan” works through changes to the income tax structure, his approach has a direct impact on employers, offsetting their GST by a fixed amount per full time employee on the payroll (pro rata for part-timers). As such it is far faster acting on unemployment, and it is budget neutral with no funds outflows even during the much shorter lags since Social Security outgoings fall identically in step with unemployment. As the Swales plan is independent of other policy measures, it is practical to use those to keep inflation down even while unemployment is improving – but a full coverage of available options would require more space than a letter allows.

  30. February 24th, 2008 at 19:27 | #30

    the Here is some material from Paul Craig Roberts that covers outsourcing issues and some things that can be done about their employment consequences.

  31. February 24th, 2008 at 19:30 | #31

    Drat, serious finger trouble. I meant to put:-

    Here is some material from Paul Craig Roberts that covers outsourcing issues and some things that can be done about their employment consequences.

  32. February 24th, 2008 at 19:46 | #32

    PML,

    Trying to get my head around the Kim Swales proposal.

    http://www.faxfn.org/feedback/03_jobs/jobs_tax.htm#23feb98a

    From what I can tell it entails:-

    1. An increase in the rate of GST.
    2. A company based rebate on GST where the rebate is a flat dollar figure times the the number of employees.
    3. An initial state where 2 cancels out 1 in terms of the government budget position.
    4. Over time 1 remains the same but 2 grows because employment will grow.
    5. The growth in employment stems from a tax bias against capital in favour of labour.

    In essence it seems to entail a basic income paid to the employee via the employer. Have I got this much correct?

  33. February 24th, 2008 at 20:26 | #33

    Terje, you are almost right – pretty much right for most practical purposes. However, some of the technical details do make a difference.

    I hope this clarifies things:-

    - You are right about 1, the way Swales put it forward. However, it’s equally practical to change other parts of the tax system to keep tax revenue unchanged between day -1 and day +1 of implementation. You don’t have to raise GST rates, it’s just more convenient (and you don’t actually have to use a GST as the carrying tax, it’s just the broad based tax with point of impact on employers that we’ve already got in place – at state level, payroll tax could be used).

    - 2 is almost right, but small businesses get into the act too, not just formally organised companies (but this is probably just a quibble). Another quibble is that it’s not really a rebate but an offset, since it only gets used in working out tax due and doesn’t actually get paid out by the ATO (someone else told me that once). Also, the precise size of the rebate/offset needs to be spelled out; initially it should match Social Security costs and on costs (and it should be fixed in dollar terms to provide an automatic stabiliser as it adjusts in real terms over time – but that’s another story).

    - 3 is stronger than “An initial state where 2 cancels out 1 in terms of the government budget position”, it actually cancels out in terms of the tax revenue position. It gets clearer if you put your points 2 and 3 the other way round.

    - 4 is accurate but incomplete. It really needs to be read along with “…budgets aren’t affected because Social Security outgoings drop in lock step”. Over time, you get budget neutrality.

    - 5 is accurate in relative terms, compared to what happens now, but it’s actually describing underlying stuff the wrong way round, like early scientists guessing whether electrons were going to be positive or negative and picking the wrong one. What is actually happening with the Swales method is, undoing a tax bias that encourages lower employment since each retrenchment spreads the cost of unemployment over the whole tax base and not just the downsizer. So it’s removing a tax bias that favours capital over labour, not putting in a new bias. The reason this matters is, putting in a bias lowers GDP and someone somewhere has to end up worse off; removing a bias actually gains you GDP – and Kim Swales’s modelling supports that this would happen.

    I hope my publications page brings out some of these things clearly enough – feedback on that would be welcome.

  34. February 24th, 2008 at 20:47 | #34

    Okay there are several questions/concerns but the key one at the moment is that I’m not clear on why you think downsizing a company currently imposes a biased abount of cost on the downsizing company. Or are you saying that it inflicts an unreasonable or biased amount of cost onto the worker that is made redundant?

  35. February 24th, 2008 at 21:04 | #35

    When a firm downsizes, the costs and benefits it has to take into account are what each worker can do for it and what it costs to keep him or her on the payroll. Once he or she is downsized, Social Security outgoings go up – but that cost gets spread over the whole tax base, so it doesn’t get factored into the firm’s decision (or the other way round, when it hires). Countries that don’t provide enough Social Security face “Vagrancy Costs” instead, which show up in the cost of policing etc. Whichever, there are real costs that the firms spread, and that’s the bias we have now. The Swales approach is a “Pigovian” fix to this market imperfection.

    Longer term, it would be better to transition to a Coasian fix with no government involvement, but the Swales approach is the one that fits present circumstances better because it is fast acting and a good match to what we have in place already, like GST.

  36. February 24th, 2008 at 23:02 | #36

    but that cost gets spread over the whole tax base, so it doesn’t get factored into the firm’s decision

    I’m not sure why it should. I tend to see it as a passive decision rather than an active one (ie I won’t decide to continue employing you next week) and as such I don’t see it as the firms cost to carry.

    However given the existance of social security it is clear that sacking somebody who then goes onto social security will impose a cost that is spread across all producers.

  37. E.D.
    February 25th, 2008 at 18:08 | #37

    To #79

    We had wage subsidies in place in the 80s but not in the 90s. LTU fell during both periods, so wage subsidies are not required.

  38. Ernestine Gross
    February 25th, 2008 at 22:20 | #38

    E.D., the conditions in the labour market were very different during the 1980s from those at present. There are 2 sides to the labour market, demand and supply. In contrast to the 1980s, at present it is a ‘tight supply’ which is alleged to be the problem. The idea of a wage subsidy in JQ’s post, as I understand it, is to lower the NAIRU (assuming it exists), by means of public payment for adjustment costs (wage subsidies)or to top up ‘internationally competitive’ wages which are too low to entice some people into the labour market. The suggestion that it is a short-term measure allows for the possibility that the financial asset value deflation, which is in progress since August last year, will reduce excess demand in the labour market and the life of the commodity boom is finite.

  39. February 26th, 2008 at 12:21 | #39

    Terje, your last paragraph at 86 should mean that you now see that the Swales method in fact undoes a market imperfection. But your second last paragraph can mean either of two things, depending on whether you are talking “should” in an engineering sense or an ethical one.

    In an engineering sense, the Social Security costs “should” reach the firm precisely because otherwise it is passive – nobody ends up connected to it, the costs get spread, and you get a market imperfection. You “should” always make costs connect to those who affect what happens.

    In an ethical sense, there isn’t any ethical duty for the firm, yes – but neither is there for the tax base, so there is no ethical guide if those are the only two possible places to put the cost; the unemployed can’t carry it, as things now are. Ideally, people would have enough independent resources of their own so they could price themselves into work and still survive without outside support – but it’s not like that so the Vagrancy Costs issue comes up, which isn’t an ethical problem at all. Something has to be done about that or suffer the consequences, and here and now we have Social Security for that – which brings us back to the practical problem, which has nothing to do with ethics. If you want an ethical side to this, look into the thinking behind Distributism, which aims at people having enough independent resources of their own.

  40. February 26th, 2008 at 13:40 | #40

    Well a basic income gives people a basic level of resources. So abolishing the minimum wage and introducing a basic income should satify that requirement.

  41. February 26th, 2008 at 15:16 | #41

    Terje, as I mentioned before, in the long run a Basic Income system, Negative Income tax and the Swales approach at the same levels are all equivalent (actually, a Basic Income has to be set below comfort levels to work properly, or people won’t need and go for top up paid work and the economy will falter from putting in a bias the other way than we have now – most schemes aim at setting it too high like that). The catch is in how quickly they take effect and how much they cost until then and after that; I have listed them in increasing order of speed and cheapness (the Swales approach costs literally nothing over and above what is already being spent on Social Security anyway). On the ethical side, a Basic Income funded in the conventional way via tax revenue has even more ethical implications, from how it is paid for, but it is a step in the direction of everyone having their own resources; you would get that from a Basic Income funded from a special fund, drawing on revenue yielding assets like shares, and the final step would be to parcel that out as individuals’ private property with some arrangement to stop that being dissipated, particularly over generations. But that brings up other areas of economic/political reform.

  42. February 26th, 2008 at 18:30 | #42

    I find the Swales approach to be more conceptually difficult. A basic income is not expensive if it is low and it replaces existing social security and the existing tax free threshold. A basic income also covers those on benefits other than the unemployed. I’m not dismissing your idea but I do see some difficulties in selling it.

  43. February 26th, 2008 at 19:12 | #43

    Terje, I came at this through game theory, so once I had the first insights (about phase changes, as it happens), it sort of fell into place for me; for someone like me, the trail was obvious. I had it all worked out before I ever found out about Kim Swales’s work along the same lines, which he reached by a different path.

    But I’m not typical; I have the remains of a very good mathematical background, though I do say so myself. So I tried to write it up with analogies, taking the mathematics out. Perhaps you might like to look at my first published article on it? Either that makes it clear, or – more likely – you will find it puzzling, and your feedback would help me make it clearer without turning out something untrue instead. Yes, it’s a hard sell if it shoots over people’s heads – but I don’t want to retreat into sneering at them for not getting it.

    For what it’s worth, the way Basic Income hits real life problems is that there’s a hard sell getting people to allow wages to fall, first in legislation and later from “stickiness” as they bargain, and even a “small” amount of Basic Income per head multiplies out to something huge over the whole labour pool. Then people would treat their new income as “free” for a while until they understood it, and so they wouldn’t appreciate it properly at first and there would be an inflationary pressure while they were still spending all of it… It would be a long haul and a rocky ride until things settled, and there might not be the political will and/or economic resources to get to the other side. What I would actually want to see is a start the Swales way, a later shift of weight to a Basic Income, then take the government out of the loop by turning supplying that into an individually endowed fund system – but as I said, that’s another story.

  44. February 26th, 2008 at 22:14 | #44

    “A basic income also covers those on benefits other than the unemployed” – Terje, in case you missed it, the Swales approach also benefits those people indirectly if it is implemented with anonymous transferrable vouchers, since they can be “cashed in” even without having a job; it’s how you transition towards a Basic Income system. (You can bet bureaucrats would be unable to see any alternative to an id based system they would be needed to run, though.)

  45. February 26th, 2008 at 22:49 | #45

    It would seem I did miss it. How do we get from a subsidy for employers based on quantity of workers to an anonymous transferable voucher?

  46. February 26th, 2008 at 22:53 | #46

    p.s. Maybe taking the mathematics out of the explaination is a mistake. Chuck around some example numbers and it might fall into place for me.

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