The RBA rate drop will further compound our ‘low growth trap’, rather than stimulating the economy

Jun 21, 2019

Welcome to Finance and Fury, The Furious Friday Edition

In this ep, we continue looking at the lucky country

look at a downward spiral in growth – low growth traps – and how it is created by what is meant to help growth?

 

Low growth trap

– The big problem comes from just looking at the numbers – and basing policy around models

1. Major part of the modern economy – looking at the numbers – I do it as well
2. Numbers can be inaccurate, or misinterpreted – sometimes the models being used for numbers don’t get the answers that were expected
3. Such as the RBA and rates – lowering them to boost the economy

 

Nothing new as to why the RBA wants to drop rates

– major banks think it will go down to 0.75% -

1. Looking to take action to help stimulate Australian economic growth, employment, wage growth, etc.
   1. The question really is if this will work as the equilibrium models suggest – based around neo-Keynesian
   2. We should be seeing a pick up in inflation (CPI) rates – which is the trick – focus on a percentage which is ever compounding under the current system – another episode
2. At least – why aren’t we seeing GDP growth, improvement in productivity or wages and employment?
   1. Big puzzle which almost every first world nation is trying to solve at the moment – and economists
3. First – look at Productivity – this measures the quantity of the economy’s (or just a particular business’s) output of goods and services relative to its inputs of raw materials, labour and capital equipment – this is theory
   1. Productivity improves when a given quantity of inputs to the production process is able to produce a greater quantity of goods and services than before. It’s most commonly measured by reference to just one of the inputs, labour. So, it’s output per unit of labour, usually per hour worked.
   2. Main way to make workers more productive is to give them more or better machines and structures to work with. That is, to invest in more physical capital.
   3. Increasing workers’ education and training – “human capital” – also makes them more productive: better able to work with more sophisticated machines, to think of ways to make machines do better tricks, and think of more efficient ways to organise the work that’s done in a mine, farm, factory, office or shop.
   4. The main way to make workers more productive is to give them more or better machines and structures to work with – this is what theory says anyway – having something to measure
4. In the present information and communication technology revolution isn’t transforming the economy to the extent that earlier general-purpose technologies – such as electricity, the internal combustion engine, the automated production line, and even running water and indoor toilets – did
5. Why doesn’t the modern-day economy show the same levels of productivity or growth as in the past?
   1. partial explanation - that much of the benefits coming from the digital revolution are going unrecognised by a system of national accounts (gross domestic product) designed to measure the industrial economy
      1. Also - low population replacement rates – birth rates not keeping up with the aging population
      2. If it keeps up - future of weaker growth in consumer spending = lower incentive for firms to invest
   2. The increased complexity of a system requires a greater input to receive the same result
      1. Example – some of the smartest people finding new ways to get around laws/taxes – not picked up in GDP growth
   3. but for the most part – due to Modern economy – focus on economies of scale for cost reduction – not massive R&D projects
      1. (synergy between companies – merge) – creates very large companies over time
      2. Apple – Jobs was an innovator – but just took existing technology and made it much better for us to use – First smartphone was by IBM more than 15 years before Apple released the iPhone

• Can see this in the share buybacks occurring – UBS and Macquarie predicted Australian companies to do more share buybacks in 2019 – if Labor won the federal election – Franking credits, higher taxes – Dividends not valuable
  1. Not only doesn’t investor get that money to spend/invest – it just inflates the share price of the company
  2. US businesses have been using their profits not to reinvest but to pay big dividends and to buy back their shares on the stock market, hoping to boost their price

 

What gets us out of this – Innovation

– continue to increase our ability to create and we will be fine – new ideas, more people creating things that work to provide value to others lives -

1. This is where some policies have had dramatic effects on our lives – the policy decision is working from an equilibrium model that is long past it’s used by date
   1. I think for the worse- house prices as an example – thanks to the compounding positive inflation rate target – very short-sighted policy
2. Theory: key to productivity improvement is investment – particularly investment by businesses
   1. But to spur business investment – you need economic growth and the expectation it will continue
   2. But it can’t include a thing like innovation into an equilibrium model – could in a complex equation
   3. What the models are picking up –
      1. Innovation is fine, but the main way some new technology is “diffused” throughout the economy is by firms replacing their old machines and structures with new ones that incorporate the latest advances.
   4. Business demand for new and better things spurs innovation – it isn’t just big companies that innovate – it is small startups that then get bought out by the big players – look at Alphabet, FB, etc. – why innovate if you can buy?
3. Innovation cant be forced – often accidents, or trying for one thing and getting something else –
   1. But if you are aimed at one goal and don’t get the result you want, you start again and disregard the by-product of the failed attempt –
   2. The government doesn’t directly invent anything – they find independent scientists and contract them to fund their research – researchers dream – recruiting people to continue doing what they were doing, but for you
   3. Investment is also an essential part of the continuous process of change in the industry structure of the economy, where changes in consumers’ preferences and other developments cause some industries to contract while others expand and new industries emerge.
   4. If firms are reluctant to invest, you don’t get enough expansion to offset the contraction.

 

But what is businesses’ main motive for investing?

Their expectations of increased demand for whatever they’re selling – marketing, higher production

1. What happens to business investment when a recession/depression occurs, or they think it might?
2. The recovery has been particularly weak in the 2007/8 crash compared to the great depression though
3. Some of our GDP growth is the product of fiscal stimulus from governments – either liquidity or spending packages
4. Low unemployment conceals a marked fall in the proportion of the population (particularly less-skilled middle-aged men) participating in the labour force - given up looking for another one - skills “atrophied” – loss of human capital to the Aus economy

 

Get it? Weak economic growth in the advanced economies is discouraging businesses from investing. Weak investment means weak productivity improvement and skills atrophy. But weak productivity means more weak growth.

1. Business investment in physical capital, and growth in human capital are key drivers of the economy’s “potential” growth rate in future years.
2. Neglect them and the economy loses its ability to grow – starts to decline and go backwards –
   1. Or remain in a low-growth trap

 

What stops drive for innovation?

6. No demand from companies for new and better products –
   1. Either no money to afford it – costs/taxes high or low revenues = low profits
   2. Limited access – barriers to entry through regulations
   3. Short term focus on maximising GDP and shareholder values -
7. What compounds this - Protectionist policies – fight against creative destruction
   1. Example - The invention of electricity – a much bigger event in our human history than the internet –
      1. People were freaking out seeing Tesla use his body as a conductive material to power a light bulb
      2. It also created unrest in labour markets – the reason why we don’t see the leary’s dancing in the street going from gas lamp to gas lamp (like Mary Poppins) – they were made redundant

• Think about it – 100% of our jobs today are vastly different to the past – almost all don’t exist, but those that do are very different looking – unless your job is to dress up like a historical recreation

1. Theory – if an economy is weak, you must help protect it through subsidies or benefits

8. These elements together just add to stagnation of the economy

 

 

Summary

– low growth trap requires innovation – attracting the best and brightest

Sadly – innovation is stagnated when so are the individuals who would otherwise be innovating – through the choice

Why do you think Communist/socialists countries crumble in every case – hard to innovate on a new engine you are working on when you are moved to a collectivised farm and given one farm animal to plough fields with – but you have to eat it as you don’t know anything about farming –

 

Next episode will dive deeper into the concept of an inflation trap – and policies to get out of it

 

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