Another big blowout in the current account, the trade account and foreign debt. Costello is blaming it all on the appreciation of the dollar but the housing boom on which the government won re-election is at least as much to blame. Here’s my take, from the Fin a couple of weeks ago.
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I’ve been arguing with the Productivity Commission about microeconomic reform and productivity growth for nearly a decade. Our first round concerned prospective estimates of the benefits of National Competition Policy, aka the Hilmer Reforms. At the time these reforms were being debated, the PC (then called the Industry Commission) put out a study estimating that the reforms would permanently raise GDP by 5.5 per cent. I looked at their analysis and found lots of problems, which i discussed in this 1997 paper and also in my book, Great Expectations, and proposed an alternative estimate of 0.7 per cent.

The PC has just released a discussion draft, of a Review of National Competition Policy Reforms and it pretty much splits the difference, suggesting a net benefit equal to 2.5 per cent of GDP. It seems to me that some of the errors I criticised have been fixed either by changes to the modelling, or by the replacement of optimistic assumptions with observed outcomes. Some others remain, though. For example, all the reductions in prices for telecommunications appear to be treated as a benefit from reform even though there’s been a long-term technologically driven trend reduction of 5 per cent per year, going for many decades. In the last few years, the rate of price decline has slowed, and even been reversed.

More on this soon, if I get time.

That’s the title of a book-length denunciation of the US-Australia FTA, by Linda Weiss, Elizabeth Thurbon and John Mathews, published by Allen & Unwin. A lot of the material will be familiar to readers of this blog, but there is an interesting chapter on quarantine. It makes the point that our quarantine laws have been successfully defended in the WTO (far from friendly to any sort of restriction on trade) but will now be subject to unaccountable bilateral processes with the US, very similar to the situation with the PBS. Even if you regard the title as a little too apocalyptic, it’s clear that this is a terrible agreement from Australia’s point of view and that, if it falls over on the issue of pharmaceuticals, that would be a very good thing.

The latest US trade data (for August) is out, with a deficit of $US54 billion[1]. This is about 6 per cent of GDP at an annualised rate. Also, the US budget deficit for 2003-4 came in at $413 billion.

But perhaps the most interesting story is one that arose from a relatively obscure decison of the WTO which banned a tax subsidy for US manufacturers that cost the US government around $5 billion a year. For a government in the fiscal position of the US, this ought to have been a small but valuable free gift in the attempt to wind back the deficit.

So what did the US Congress do? It passed a bill that not only replicated the effect of the prohibited subsidy, but extended it by drastically widening the class of firms classed as manufacturers. Getting support proved a little problematic, so the votes were rounded up by inviting every member of Congress to insert their own preferred piece of legislation, assisting every industry from tobacco to tackle boxes (a big tackle box manufacturer is in House Speaker Dennis Hastert’s district). The total cost is estimated at more than $140 billion over ten years[2]. As Senator Charles Grassley argues, largesse distributed as widely as this ceases to be special-interest pork-barreling and becomes more like a comprehensive industry policy

“For all the unfair carping about this bill being a special-interest bill, nearly every member raised narrow-interest provisions. So, if there’s some fault about different provisions coming up, we all share that. We all do it.”

Grassley appears to be right. On this legislation, with the usual negative, carping, exception of John McCain[3], consensus ruled the land. Liberals, centrists and rightwing Republicans all lined up to support the bill.

If I was a holder of US government debt, I’d be getting a bit worried right now. But I’m a notorious pessimist.

As various people have argued, there’s a neo-Bretton Woods system in operation in which Asian central banks (formerly Japan, now China) finance whatever trade and budet deficits the US choose to run. So, there’s no need to fret. World capitalism can safely rely on the good judgement and good will of the Chinese Communist Party.

fn1. Australia is one of a handful of countries with which the US has a bilateral trade surplus. Maybe relevant in considering the FTA.

fn2. There are various offsets from closing tax shelters, which are supposed to balance the cost. But the figures are rubbery, and this was money the government should have gone after in any case.

fn3. Why does he hate America so much?

Among the issues that won’t be addressed in detail in the current election campaign is the case for, and against, welfare reform along the lines adopted in the US. Although the Howard government has made various changes aimed at increasing ‘mutual obligation[1]’, there has been nothing approaching the reforms to the main pure welfare program in the US, then called Temporary Aid for Needy Families, and received primarily by single-parent families. Among those who still think substantial measures of microeconomic reform are needed, welfare reform along US lines is at the top of the list, and Wisconsin, where Governor Tommy Thompson slashed welfare rolls, is generally held out as the model.

Although there are various rationales for welfare reform, the only one I think worth considering is the claim that welfare perpetuates poverty. While relieving immediate distress, it is argued, welfare encourages a culture of dependence that perpetuates poverty. Against this, I’d put the argument that what matters most in preventing dependence is the availability of good jobs, and that a government commitment to full employment is what is needed for a genuinely mutual or reciprocal obligation to work.

There’s not likely to be a convincing and rigorously defensible empirical resolution of this debate any time soon. However, one telling piece of anecdotal evidence is worth a dozen regressions[2], so I thought I’d check out the Wisconsin example. What I found is a report with the headlines

Poverty rate hits 10-year high

State’s struggles also evident in growing number of uninsured: 11%

The rise in the poverty rate[3] is attributed mainly to the loss of manufacturing jobs, rather than to adverse effects of welfare reform. This is consistent with my general view that we need to look harder at employment and unemployment. But reform is clearly playing a significant role

We have gone since 1996, when Pay for Performance hit, from distributing 1.5 million pounds of food to 10 million on an emergency basis,” Tussler [executive director of Hunger Task Force of Milwaukee[ said, referring to the reform requiring work or job-seeking in exchange for welfare benefits.

I’m not claiming that this example proves that welfare reform increases poverty. But it’s hard to see how Wisconsin can be regarded as a successful exemplar of welfare reform when the poverty rate is higher than it was before the main phase of reform, and still rising.

fn1. As many have pointed out previously, the current government’s notion of mutual obligation involves drastically reducing its own obligations, while increasing those place on benefit recipients

fn2. Irony tags were clearly needed here, but Textile doesn’t support them

fn3. This is an absolute poverty measure, based on a poverty line set in 1965, and adjusted since then only for inflation. Of course, it’s not absolute by comparison with third world countries, and it’s about twice the income that was considered to constitute poverty 100 years ago.

After summarising the generally gloomy prospects for IraqPaul Krugman writes in today’s NYT

much of U.S. policy in Iraq – delaying elections, trying to come up with a formula that blocks simple majority rule, trying to install first Mr. Chalabi, then Mr. Allawi, as strongman – can be seen as a persistent effort to avoid giving Grand Ayatollah Ali al-Sistani his natural dominant role. But recent events in Najaf have demonstrated both the cleric’s awesome influence and the limits of American power. Isn’t it time to realize that we could do a lot worse than Mr. Sistani, and give him pretty much whatever he wants?

He’s right, but it’s important to look ahead to the next step. Sistani has rejected violent resistance to the American occupation, but has always opposed the occupation and has refused to meet with the Americans or their representatives. Assuming elections go ahead and a Shia majority government is elected, it will be under intense pressure to demand the withdrawal of US troops, regardless of the security situation.

Among the possible responses to this, the really stupid one (and therefore the one the Bush Administration will probably pick, if Bush is re-elected) would be to invoke Article 59 of the Transitional Administrative Law approved by the unelected Iraqi Governing Council, which allows for US troops to remain in effective control of the country until a permanent constitution is in place.

A more plausible solution, but one that would probably be unacceptable even to a Kerry Administration, would be to hand over command of a scaled down (but still mostly American) force to a UN commander, operating subject to the control of the elected government. The Iraqi government would probably accept such a compromise.

The final option would be to pull out as requested, and leave the Iraqis to sort out the resulting mess. It’s looking increasingly likely that this will be the actual outcome, and perhaps it would be better than what we have at present.

The seasonally adjusted balance of trade in goods and services came in a deficit of $2.7 billion. If continued at an annual rate, this would amount to about 4 per cent of GDP, implying a current account deficit in excess of 67 per cent.

There’s plenty of debate about whether large current account deficits can be sustained indefinitely. But there isn’t (or shouldn’t be) any such debate about large deficits in the goods and services balance. A large and stable deficit on goods and services necessarily leads to an explosion in net debt and in the current account deficit[1]. This can’t be sustained, and therefore won’t be, but the process of adjustment may not be pleasant.

As various people have pointed out, one contributory factor is the poor performance of the “elaborately transformed manufactures” sector, on which high hopes were set in the early 1990s. More generally, it’s difficult to square this outcome with claims of a miraculous productivity performance in Australia.

I don’t suppose that this will have much impact on the election campaign. But it helps to point up the fact that the government’s reputation as good economic managers is as much the product of good luck as of good judgement. Running sustained large current account deficits is a gamble that world capital markets will continue to take the relaxed view of such deficits that they have in the last decade as regards OECD countries, rather than suddenly changing their minds as they have done in relation to Mexico, Asian countries. Argentina etc.

fn1. If the rate of growth of nominal GDP is higher than the rate of return received by foreign lenders and investors, a small deficit on goods and services can be consistent with a stable ratio of debt to GDP. But that isn’t the case for Australia. The ten-year government bond rate is 6.25 per cent, which is about equal to nominal growth, and private borrowers would mostly be paying rates higher than this.