Brexit, Trump and the TPP mean Australia should pursue more bilateral trade agreements

From The Conversation.

Brexit, Trump’s protectionist agenda and the debacle of getting everyone to ratify the unpopular Trans-Pacific Partnership (TPP) are all a global trend towards bilateral trade agreements.

This is good news for Australia. With its manifold set of strong free trade agreements, Australia is geared up to reap the early gains of this new trend.

The domestic squabble between Prime Minister Malcolm Turnbull and Opposition Leader Bill Shorten on whether the “the TPP is dead in the water” meant that Turnbull’s ongoing support for the Regional Comprehensive Economic Partnership (RCEP) went unnoticed. This signals that, unlike the TPP, the Chinese-led trade deal RCEP is alive and well, and that both sides of Australian politics support it.

Considering the existing spaghetti bowl of international economic partnerships, Australia is already in the fast lane of bilateral trade agreements with the US and China. In fact, Australia is the second largest economy and trading partner of the only six countries that have in place free trade agreements with both the US and China. The group includes South Korea, Singapore, Chile, Peru’ and Costa Rica.

If Australia quickly wraps free trade agreements with Canada, the European Union and the United Kingdom, Australia will be the only major trading link among these countries, with evident growth opportunities on favourable terms.

When it comes to trade deals already in force, Australia’s trade portfolio includes many bilateral agreements, but only one regional trade agreement (with the Association of Southeast Asian Nations).

Department of Foreign Affairs and Trade/The Conversation, CC BY-ND

Trade deals with multiple countries are dead

Promoting international trade has always been important to Australia’s economy, to encourage growth, attract investment and support business. For the past two decades Australia has been expanding its trade policy agenda with multilateral, regional and bilateral trade agreements.

There are only two multilateral trade agreements under negotiation which involve Australia. One is under the World Trade Organisation (WTO) umbrella (the Environmental Goods Negotiations) and the other is in competition with the WTO system (the Trade in Services Agreement – TiSA).

The tumultuous political events of 2016 in the US and Europe confirm Kevin Rudd’s remark that “the West has turned inward”, while the Asia Pacific region is emerging as the torchbearer for free trade and economic integration.

For the past few years there’s been disagreement on which type of agreement is best for Australia’s trade policy: multilateral, regional or bilateral.

The failure of the WTO’s Doha round of trade negotiations has undermined the credibility of the multilateral trading system. With the US and Japan denying China the market economy status sanctioned by its WTO accession, multilateralism is further out of question.

When a country grants China market economy status, it can no longer impose punitive anti-dumping tariffs on Chinese-made goods. More than ten years ago, Australia was fast to recognise China’s full market economy status as a precondition of the China-Australia Free Trade Agreement (ChAFTA), which entered into force on 20 December 2015.

If multilateralism is dead, regional trade agreements are also not looking so good outside of Asia. With the rise of Trump and anti-EU sentiment, the Transatlantic Trade and Investment Partnership (TTIP) is lost at sea, and so is the EU-Canada Comprehensive Economic and Trade Agreement (CETA).

The benefits of bilateralism

Australia has a once-in-a-generation economic opportunity to exploit the cracks opened in the international trading system by the stark return to bilateral agreements. Australia is already poised to negotiate two such agreements with Canada and the EU.

Brexit is creating further ripples in the economic diplomacy waters. For example, in Canberra there are loud voices calling for “absolutely free” trade between Australia and the UK. According to some, a full-blown China-US trade war fought on currency manipulation is the single biggest economic threat to Australia. A falling Chinese currency in combination with US protectionist measures would dampen the Chinese economy by way of reduced volumes of exports and higher interest rates spreading across the Asia Pacific and pushing down the price of commodities.

However, it’s highly unlikely that monetary dynamics alone will damage Australia’s “rocks and crops” economy. The growing productivity of the agricultural and mining sectors is strong enough to rise above global tensions and falling commodity prices. Australia’s export volumes in key markets are poised to further rise in a situation where trading partners will already be warring for the best market and investment opportunities.

A protectionist western economy across the Atlantic will further swing the global pendulum of economic growth to Asia. It will also amplify the positive effects of further economic integration in that region for Australia.

When the RCEP comes into force, Australia will have privileged access to China’s One Belt One Road (OBOR) initiative, the so called new Silk Road. This development will lead to massive infrastructure investment and trade opportunities for Australia, even more so as it has the comparative advantage of being a highly developed economy with privileged access to Western know-how.

As cynical as it may sound, at present Australia’s economic fortunes depend on juggling free trade with both a commanding Asian region and a disunited west. Essentially, if Australia manages to keep a trade policy that is geopolitically neutral, its economy will thrive on unsavoury developments.

Some of these include the success of Trump’s protectionist agenda, which may deteriorate the US relations with NATO and the EU, to the point of fuelling European nationalism and disintegration.

Another questionable development, yet positive for Australia, is Japan’s re-militarisation to contain China’s rise. The preservation of the postwar institutional framework that guarantees economic openness and the prospect of economic and political security in the the Asia Pacific region may soon require tough choices for Australia and Japan.

With Japan standing in for the US security role in East Asia, Australia would take a sweet deal to become the neutral and peace-monger Switzerland of Asia.

Author: Giovanni Di Lieto, Lecturer, Bachelor of International Business, Monash Business School, Monash University

Theresa May confirms: Britain is heading for Brexit Max

From The Economist.

For the past few months Theresa May and her ministers have allowed some ambiguities to swirl around Britain’s future relationship with the European Union. Yes, she confirmed in her conference speech in October, Brexit would take it beyond the jurisdiction of the European Court of Justice and the EU’s free movement regime. Some found this hard to square with reports that special arrangements would be sought for parts of the British economy (like the City of London and carmaking) or with Mrs May’s assurance to businesses that she would seek to avoid a “cliff edge” on Britain’s exit from the club. Many in other European capitals questioned whether Britain would leave at all.

To the extent that such uncertainties persisted despite her endless choruses of “Brexit means Brexit”, at a speech to EU ambassadors in London on January 17th Mrs May put them to the sword. Britain will leave the single market and the customs union, and will thus be able to negotiate its own trade deals with third-party economies. It will not pay “huge sums” to secure sectoral access (a phrase whose precise meaning now matters a lot). She wants this all wrapped up within the two years permitted by Article 50, the exit process she will launch by the end of March; ideally with a “phased process of implementation” afterwards covering things like immigration controls and financial regulation. In other words there will be no formal transitional period. There will, in fact, be a cliff edge of sorts.

This reflects two realities to which policymakers in Britain and on the continent must now get accustomed. First, Mrs May unequivocally interprets the vote for Brexit as a vote for lower immigration even at the cost of some prosperity. Never mind that the polling evidence supporting this assumption is limited: such is now the transaction at the heart of the new government’s political strategy. Second, even allowing for a certain amount of expectation-management, it seems Mrs May is not placing huge importance on the outcome of the talks. She wants a comprehensive free-trade agreement (FTA) based on the one recently signed between the EU and Canada; but where “CETA” took about seven years to negotiate, she has permitted herself two. She said that this might cover finance and cars, but also recognised the importance the EU places on the “four freedoms” (making freedom of movement a condition of market membership), suggesting a realism about the extent of any such FTA in the narrow time constraints available. Mrs May also wants some associate membership of the customs union but declared herself relaxed about the details. In short: she will do her best, but if the talks come to little or nothing, so be it.

Of course, they will be tough. The prime minister will want firstly to maximise the scope of the FTA, secondly to maximise the benefits of any associate relationship with the customs union and thirdly to minimise the precipitousness of the cliff off which British firms will fly in 2019. She hinted at how she intended to do so, characterising the country’s current defence and security co-operation with the continent as a possible negotiating chip and warning that her government could “change the basis of Britain’s economic model” (i.e. turn it into a tax haven) if the EU does not play nice. She also said that she would be willing to walk out on the talks: “no deal…is better than a bad deal.”

So Britain’s economy is in for a rough ride and, though the government will try to smooth it out, the priority is getting the country out of the EU in the most complete and rapid way possible. If the price of this priority is economic pain, then pay Britain must. All of which gives firms some of the certainty they have craved since June 23rd: those fundamentally reliant on continental supply chains or the EU “passport” for financial services, say, now have the green light to plan their total or partial relocation. It also means the Brexit talks will be simpler and perhaps even less fractious than they might have been had Britain tried to “have its cake and eat it”. The country will eat its cake and live with an empty plate afterwards. Brexit really does mean Brexit.

The Global Economic Landscape Has Started Has to Shift

From iMFDirect.

Today we released our update to the World Economic Outlook.

An accumulation of recent data suggests that the global economic landscape started to shift in the second half of 2016. Developments since last summer indicate somewhat greater growth momentum coming into the new year in a number of important economies. Our earlier projection, that world growth will pick up from last year’s lackluster pace in 2017 and 2018, therefore looks increasingly likely to be realized. At the same time, we see a wider dispersion of risks to this short-term forecast, with those risks still tilted to the downside. Uncertainty has risen. 


Our central projection is that global growth will rise to a rate of 3.4 percent in 2017 and 3.6 percent in 2018, from a 2016 rate of 3.1 percent. Much of the better growth performance we expect this year and next stems from improvements in some large emerging market and low income economies that in 2016 were exceptionally stressed. That being said, compared to our view in October, we now think that more of the lift will come from better prospects in the United States, China, Europe, and Japan.

A faster pace of expansion would be especially welcome this year: global growth in 2016 was the weakest since 2008–09, owing to a challenging first half marked initially by turmoil in world financial markets. General improvement got under way around mid-year. For example, broad indicators of manufacturing activity in emerging and advanced economies have been in expansionary territory and rising since early summer. In many countries, previous downward pressures on headline inflation weakened, in part owing to firming commodity prices.

A significant repricing of assets followed the U.S. presidential election. Its most notable elements were a sharp increase in U.S. longer-term interest rates, equity market appreciation and higher long-term inflation expectations in advanced economies, and sharp movements in opposite directions of the dollar—up—and the yen—down. At the same time, emerging market equity markets broadly retreated as currencies weakened.

Of course, asset markets adjust not just to unexpected current events, but to shifting expectations of future events. Most commentators have interpreted the post-election moves as predicting that U.S. fiscal policy will turn more expansionary and require a swifter pace of interest rate increases by the Federal Reserve. Markets have noted that the White House and Congress are in the hands of the same party for the first time in six years, and that change points to lower tax rates and possibly higher infrastructure and defense spending.

In light of the U.S. economy’s momentum coming into 2017, and the likely shift in policy mix, we have moderately raised our two-year projections for U.S. growth. At this early stage, however, the specifics of future fiscal legislation remain unclear, as do the degree of net increase in government spending and the resulting impacts on aggregate demand, potential output, the Federal deficit, and the dollar.

There is thus a wider than usual range of upside and downside risks to this forecast. A sustained non-inflationary growth increase, marked by higher labor force participation and significant expansion of the U.S. capital stock and infrastructure, would allow a more moderate pace of interest rate increases in line with the Federal Reserve’s price stability mandate.

On the downside, if a fiscally-driven demand increase collides with more rigid capacity constraints, a steeper path for interest rates will be necessary to contain inflation, the dollar will appreciate sharply, real growth will be lower, budget pressure will increase, and the U.S. current account deficit will widen.

This last scenario, one with a widening of global imbalances, intensifies the risk of protectionist measures and retaliatory responses. It would also imply a faster than expected tightening of global financial conditions, with resulting possible stress on many emerging market and some low-income economies. Some emerging and especially low-income commodity exporters could benefit from higher export prices, but importers would then lose. The details of the U.S. policy mix matter; and as these become clearer, we will adjust our forecast and spillover assessment.

Among emerging economies, China remains a major driver of world economic developments. Our China growth upgrade for 2017 is a key factor underpinning the coming year’s expected faster global recovery. This change reflects an expectation of continuing policy support; but a sharp or disruptive slowdown in the future remains a risk given continuing rapid credit expansion, impaired corporate debts, and persistent government support for inefficient state-owned firms.

At the global level, other vulnerabilities include higher popular antipathy toward trade, immigration, and multilateral engagement in the United States and Europe; widespread high levels of public and private debt; ongoing climate change—which especially affects low-income countries; and, in a number of advanced countries, continuing slow growth and deflationary pressures. In Europe, Britain’s terms of exit from the European Union remain unsettled and the upcoming national electoral calendar is crowded, with possibilities of adverse economic repercussions, in the short and longer terms.

We continue to recommend a three-pronged policy approach relying on fiscal and structural policies alongside monetary policy, but one that is tailored to country circumstances.

Some advanced economies are now operating at close to full capacity, for example, Germany and the United States. In these, fiscal policy should focus, not on short-term demand support, but on increasing potential output through investments in needed infrastructure and skills, as well as supply-friendly, equitable tax reform. Policymakers in these economies should also turn their attention to longer-term fiscal sustainability, while monetary policy can follow a data-dependent normalizing path.

Structural reform remains a priority everywhere in view of continuing tepid productivity growth, although in many cases appropriate fiscal support can raise the effectiveness of reforms without worsening governments’ fiscal positions.

Financial resilience is another universal priority and requires stronger financial regulatory frameworks, better focused on key problem areas. Countries can do much on their own to improve financial oversight and institutions, but not everything, and continuing multilateral financial regulatory cooperation is vital.

Social dislocation due to globalization and, even more, to technology change is a major challenge that will only intensify in the future. One result has been wider inequality and wage stagnation in many countries. Rolling back economic integration, however, would impose aggregate economic costs without reducing the need for government investment in well-trained, nimble workforces, along with policies to promote better matching of available jobs to skills.

On this Martin Luther King Jr. Day in the United States, we do well to acknowledge a key takeaway from 2016: sustainable growth must also be inclusive growth.


Centrelink data-matching problems show the need for a government blockchain

From The Conversation.

Governments across the globe are experimenting with the blockchain, the technology behind Bitcoin, as a way to reduce costs and provide more accountability to the public. In Europe alone, the United Kingdom, Ukraine and Estonia are experimenting with blockchains to fight corruption and deliver public services.

Australia, too, is looking at what a blockchain might achieve. The recent problems with Centrelink’s automated data-matching system show precisely where a government blockchain would fit in.

Rather than siloing our data in government agencies, we could create a single source of information. This would speed up our interactions with government, while reducing errors and fraud.

What is a blockchain?

The blockchain is a kind of public database, one stored simultaneously on a bunch of different computers. When a new transaction occurs it is verified (otherwise known as “mining” or “consensus”), encrypted and added to the database.

The most famous example of the blockchain is Bitcoin, a crypto-currency built upon the blockchain. However, the blockchain is suitable for many other applications, not just financial transactions. For example, the blockchain could be used to authenticate that a diamond has not come from an illict source, or for buying and selling property.

A government blockchain

For the government’s purposes, the killer feature of the blockchain is that it is a way to record transactions so that they are transparent and cannot be altered or tampered with. When used to track fish through a supply chain, for instance, it allows customers and restaurants to follow where the fish has been and have confidence in the data.

When applied to a government context, these capabilities could be useful for collecting tax, delivering benefits, or regulating business. From the public’s point of view, this could enable us to track government spending, eliminate fraudulent transactions, reduce errors in data processing and speed up service delivery to almost real time. It could be useful almost anywhere records are kept.

All the while the public could be more confident about the accuracy and integrity of the data being held.

In practice

The Australian government makes benefit payments and provides support services through Medicare, Centrelink and Child Support services. It also collects information through numerous other agencies, such as the Australian Tax Office. A government blockchain could record the transactions about a citizen and link together information about health, welfare and child support.

The information would be entered only once into the blockchain by any one of these agencies. There would be no need for the data to be re-entered or matched again. Thus errors that occur in data processing as information is passed on down the line will be eliminated, avoiding some of the issues with the current Centrelink system.

Further, once data is entered it cannot be altered or changed in any way without proper authentication. Any authorised officer within the government could then access the information in the blockchain, avoiding a paper-pushing exercise between government departments. All of your data would be in one place.

We could go even further, as the blockchain would also allow other services to be processed through an app, as the UK is trialling with welfare payments.

The overall cost savings, reduction in bureaucracy and increased responsiveness to helping people in need could be immense. All we need is the government to invest in its own blockchain.

The challenge is making it legitimate

The essence of a blockchain is to reduce the reliance on centralised systems (such as the government), replacing it with a system with inherent accountability, transparency and trust. The original blockchain concept achieved this by being open, like the internet (also known as unpermissioned), relying on independent, anonymous “miners” to validate transactions. This guarantees the integrity of the data as no-one knows who the miners are to bribe or bully them into underhanded actions.

However, some might view a government-run, “permissioned” blockchain with suspicion. The trust of the public would need to be gained. A government blockchain would not be open, and we would have to rely on the government to approve all of the transactions. This negates some of the benefit offered by a blockchain. The legitimacy and trust would have to come from the government itself.

Thus a government-run blockchain would not be without its challenges. But if an Australian government blockchain is developed and allowed to succeed, then the potential benefits could be enormous. Society as we know it will be disrupted!

Author: Christine Helliar, Professor School of Commerce, University of South Australia

Trump’s brand of Carrier-style dealmaking won’t work

From The Conversation.

In late November, President-elect Donald Trump announced that he had reached a deal with Carrier to keep about 800 manufacturing jobs in Indiana from moving to Mexico. After the announcement, we learned that the Indiana Economic Development Corporation would give US$7 million in tax credits and grants to Carrier’s parent company in exchange for keeping the jobs in the state.

Trump proudly praised the agreement as a “great deal for workers” and said that it was part of a larger approach to keep jobs at home, saying “this is the way it’s going to be.”

Having the chief executive of the United States negotiate individualized deals with corporations is certainly a new approach to economic policy nationally, though it is not without precedent. In fact, state governments have been negotiating targeted incentives with corporations for decades.

My research focuses on why states use incentives to attract and retain investment from corporations and whether they are effective. My work, as well as that of many others, shows that these deals do not create the jobs and economic growth they are purported to.

A common economic tool

Every year, states spend billions of dollars to entice companies to create jobs within their borders. These inducements include some combination of property, sales and income tax credits and rebates, tax abatements, cash grants and cost reimbursements.

The deals are meant to reduce costs for the businesses that receive them in order to encourage their investment and job growth in a particular location. The most prominent packages usually grab headlines nationally.

In 2013, for example, Boeing received $8.7 billion in tax breaks from Washington state to secure the production of the 777x. This record-breaking package came shortly after Boeing had received $900 million from South Carolina for opening a new 787 assembly plant in Charleston.

Other examples include Tesla receiving $1.3 billion from Nevada in 2014 to subsidize a battery factory outside Reno and the Los Angeles Rams collecting $180 million in sales tax revenue from Inglewood for relocating there from St. Louis this year.

Just as Carrier threatened to move jobs to Mexico and promptly received a tax break, so too did Sears receive millions from Illinois to keep its headquarters in Chicago back in 1989.

From 1984 to 2012, incentive spending increased in the states from about $500 million per year to about $13 billion per year, according spending data gathered by the Good Jobs First Subsidy Tracker.

Has it worked?

Despite the hundreds of billions of dollars in incentives thrown their way, many companies have still decided to move more manufacturing jobs and corporate headquarters overseas.

This is because corporations consider many other factors when making decisions about where to build a factory or establish a tax home. In a 2016 survey, incentives lagged behind skilled labor, labor costs, highway access, corporate tax rates, available buildings, construction costs, proximity to markets and quality of life as important factors for location decisions.

For example, scholars have found that the Sun Belt has been able to attract investment away from the Rust Belt because it has lower wages but similar access to the interstate highway system.

In other words, jobs move (or don’t) based on the overall range of costs facing employers, which are determined by larger economic trends and policies and not necessarily by individually negotiated deals. When subsidies do matter is when corporations are choosing between equally strong locations. In those situations, incentives serve as “deal sweeteners” but don’t change the fundamental reasons for why the location was considered in the first place.

In light of the realities of corporate location decisions, there is scant evidence to support the arguments that targeted incentives produce economic growth. Rather, the evidence shows that they tend to fail to achieve their intended goals.

Often, subsidies fall short of job creation targets and fail to create growth, even if they retain jobs. As University of Iowa scholars Alan Peters and Peter Fisher argue, based on a review of several studies of their impact, “incentives work about 10 percent of the time and are simply a waste of money the other 90 percent.”

One reason why scholars have struggled to measure the impact of incentives is because of the complexity of the economy. Economic growth is affected mostly by national and international forces. State economic development strategies have little effect when compared with broad national economic policies.

The wrong kind of impact

Subsidies still can have an effect on economic behavior, just not in the way they were intended, such as by encouraging rent-seeking.

Critics of the Carrier deal have already noted that Trump may have opened the federal government up to increased threats from companies to move overseas unless they receive more incentives (aka rent-seeking). In the days following the Carrier deal, Ford Motor (already one of the largest recipients of state-level spending) expressed a willingness to make a deal with Trump to retain jobs scheduled to move overseas. In a first move, Ford announced that it had canceled a planned investment in Mexico and will instead invest $700 million in its Flat Rock, Michigan, plant.

There is also some evidence that incentives can exacerbate economic inequality.

Incentives, when used to influence location decisions, tend to be awarded to the largest and wealthiest corporations. These corporations need the money the least of all businesses and usually receive the money for making investments they likely would have made anyway in order to remain competitive. The result is that fewer resources are available for education, workforce training and social services. As a result, the gap between rich and poor tends to grow.

Raising red flags

While it is laudable that several hundred Indianans get to celebrate the holiday season with their jobs secure, evidence from the states raises red flags on the viability of targeted incentives as a national policy for growth.

Not only would Trump be needing to negotiate several packages per week in order to have a noticeable effect on the U.S. economy, doing so opens the government up to increased demands for subsidies, most likely from the wealthiest corporations, and could exacerbate income inequality in America.

Author: Joshua Jansa, Assistant Professor of Political Science, Oklahoma State University

Have The U.S. Stock Bulls Got It Wrong?

From Bloomberg.

Amundi SA, Europe’s largest money manager, says investors who have driven U.S. stock markets to record highs in expectation of fiscal stimulus from the Trump administration may be in for a surprise.


While a pivot to government spending and tax cuts may prolong the economic expansion in the U.S., Republican lawmakers will insist that fiscal measures don’t push up the deficit, Didier Borowski, the Paris-based asset manager’s head of macroeconomics, said in an interview. Even if President-elect Donald Trump succeeds in delivering stimulus, it won’t have an impact before next year, he said.

“Following the vote for Trump, markets have reacted as if there were only upside risks,” Borowski said in an interview in Munich. “U.S. equity markets could go further into bubble territory as risks are becoming increasingly asymmetric. That would be an opportunity to reallocate funds to bond markets.”

Trump’s surprise victory in the U.S. presidential election in November has driven investors out of bonds and into equities, accelerating a massive flow of funds that some investors say may last for years and spell the end of the multi-decade rally in bonds. The value of global equities climbed to $68 trillion from about $65 trillion the day before the election. Bonds have lost about $2 trillion in that time.

Financial market observers and investors are split about the continuation of that trend, sometimes named the “great rotation” from bonds to stocks, with Charles Schwab Corp.’s chief global strategist Jeffrey Kleintop anticipating the it has years to run. Amundi, which is controlled by Credit Agricole SA, says a more likely scenario is that bonds may rebound because growth will probably continue at a slow pace.

“Global uncertainties are at an unprecedented level with Brexit, Trump and elections in Europe,” Borowski said, adding the biggest risk would be a trade war between the U.S. and China. “The bond market isn’t dead yet. There are many unpredictable risks still looming and that’s why we really doubt that bond yields can jump that much. Investors will keep an exposure to U.S. Treasuries as a safe haven.”

Investors may also return to Europe, once the outcome of elections removes political uncertainty in the region, he said.

“Some investors have stayed clear of Europe following Brexit,” Borowski said. “At some point in the coming months we will be reassured concerning the political risks in Europe, especially in France, where we don’t expect French National Front leader Marine Le Pen to be elected.”

Amundi was created in 2010 when Credit Agricole and Societe Generale SA combined their asset-management businesses. It went public in 2015 to fund its international expansion as Societe Generale sold its stake.

Amundi agreed in December to buy Pioneer Investments from Italy’s UniCredit SpA for about 3.5 billion euros ($3.7 billion) in cash, bringing assets to more than $1.3 trillion and making it the world’s eighth-largest asset manager.

Credit Looks for US to Realise Potential

Moody’s says today’s still underperforming US economy leaves plenty of room for significant improvement in 2017 without the unwanted side effect of significantly faster price inflation. The US economy may be far from realizing its full potential.

January 2017 marks the 91st month of the current economic recovery and yet the US economy’s rates of resource utilization leave considerable room for additional production. In terms of the latest three-month averages, only 75.2% of industrial capacity was in use, while payrolls approximated a relatively low 57.0% of the working-age population. When previous upturns were of similar vintage in October 1998 and June 1990, the industrial capacity utilization rate averaged 82.7% and payrolls averaged 59.9% of the working age population.

Will this be the first economic recovery since the 1930s where the capacity utilization rate’s moving three month average fails to reach the 80% mark, where the latter is typically associated with the sufficient utilization of potential industrial output? Thus far in the current upturn, this version of capacity utilization has risen no higher than the 78.6% of Q4-2014. Figure 1 indicates a good deal of room to grow for industrial capacity utilization and, thus, lends support to the possibility of faster than 3% real GDP growth. By comparison, real GDP has risen by only 1.8% annualized, on average, for the current recovery to date and not since 2005’s 3.3% has growth managed to reach 3% for an entire calendar year. (Figure 1.)

In a similar vein, late 2016’s relatively low ratio of jobs to the working-age population preserves the possibility of a fuller utilization of US labor resources that could supply a noticeably faster rate of economic growth. However, the recent absence of labor productivity growth limits the extent to which faster jobs growth can quicken economic growth. (Figure 2.)

Yes, late 2016’s comparatively low rates of resource utilization hint of considerable upside potential for US business activity. Nevertheless, whether such potential is realized depends on a far from assured quickening of expenditures. For one thing, the recent strengthening of the dollar exchange rate heightens the importance of an acceleration by US household spending, which requires improved prospects for employment income.

The critical role of household expenditures cannot be overemphasized. Regardless of the more favorable tax treatment of capital outlays, businesses are only likely to significantly increase their production capabilities if they are convinced of sufficiently profitable markets for new and existing products.

Thus, businesses are likely to heed the warning of slower household spending growth implicit in the dip by payrolls’ annual increase from Q1-2015’s cycle high of 2.2% to Q4-2016’s 1.6%. The last two times payrolls decelerated in a similar manner, recessions arrived within 18 months.

Jobs outlook suggests spreads are too thin

Corporate credit is now very much priced for faster economic growth that will require the fuller utilization of US productive resources. The correlation between the high-yield bond spread and the moving three-month average of payrolls’ monthly percent change is a strong 0.78. Fourth-quarter 2016’s average monthly increase by payrolls of 0.11% predicts a 531 bp midpoint for the high-yield bond spread.

Accordingly, January 11’s far thinner high-yield bond spread of 405 bp implicitly expects faster jobs growth. However, as inferred from the Blue Chip consensus expectation of a drop by payrolls’ average monthly increase from 2016’s 180,000 jobs to 2017’s 161,000 jobs, the high-yield spread may soon be closer to 500 bp than to 400 bp.

Unemployment rate overstates labor market tightness

As opposed to the unemployment rate, the ratio of payrolls to the working-age population may now be the better estimate of labor market utilization, owing to the current recovery’s large number of labor force dropouts. For example, when the unemployment rate previously first fell to Q4-2106’s 4.7% in March 2006 and November 1997, payrolls averaged 60.2% of the working age population, which was well above Q4-2016’s 57.0%.

As inferred from the unemployment rate’s statistical relationship with the ratio of payrolls to the working-age population since 1988, Q4-2016’s ratio of 57.0% is ordinarily accompanied by a jobless rate of 6.8%. Even after allowing for how an aging workforce exerts a downward bias to the ratio of payrolls to the working-age population, the 4.7% unemployment rate still probably overstates the degree of labor market tightening. (Figure 3.)

In addition to an atypically low labor force participation rate, the 4.7% unemployment rate overstates labor-market tightness because of a relatively high U6 unemployment, or under-employment, rate. When the jobless rate’s moving three-month average previously first fell to 4.7% in March 2006 and November 1997, the U6 under-employment rate averaged 8.4%, considerably lower than Q4-2016’s 9.3%.

Nevertheless, the US labor market is firming up, as seen in the yearly increase of the average hourly wage from the 2.5% of Q4-2015 to Q4-2016’s 2.7%. However, when the unemployment rate’s three-month average last fell to 4.7% in Q1-2006, average hourly earnings posted a comparable increase of 3.4%. During the previous cycle, the yearly increase of the average wage’s moving three-month average peaked at the 3.8% of Q3-2006. By the time the moving three-month averages of the jobless rate and the U6 under-employment rate bottomed simultaneously in May 2007 (at 4.4% and 8.1%, respectively), the average hourly wage’s annual increase had slowed to 3.4%.

Despite an earlier acceleration by the hourly wage’s moving yearlong average from the 2.0% of the span-ended September 2004 to the 3.7% of the span-ended March 2007, the annual rate of growth for the core PCE price index peaked at a relatively modest 2.4%. By comparison, the core PCE price index rose by 1.7% annually during the three-months-ended November 2016. The possibly unfinished strengthening of the dollar exchange rate will limit the upside for US price inflation and just might intensify the price deflation still afflicting a number of internationally traded goods.

Ratio of jobs to the working-age population outshines other possible inflation indicators

The market’s recent obsession with December’s 2.9% yearly jump by average hourly earnings may have been unwarranted. After all, the annual rate of core PCE price index inflation generated a meaningless correlation of 0.04 with the yearly percent change of the average hourly wage.

By contrast, the ratio of payrolls to the working-age population again offers useful insight regarding labor market tightness and inflation risk. Since 1992, the year-to-year percentage point change for the ratio of payrolls to the working-age population shows a correlation of 0.31 with the annual rate of core PCE price index inflation, where this and forthcoming comparisons employ moving three-month averages.

As far as predicting core PCE price index inflation, the ratio of jobs to the working-age population also outperforms both the unemployment and U6 under-employment rates. For example, the jobless rate and its year-to-year percentage point change showed weaker correlations of -0.22 and -0.24 with the annual rate of core PCE price index inflation, while the U6 under-employment rate posted comparably measured correlations of -0.23 and -0.22, respectively. Thus, expectations of a continued mild rise by the ratio of payrolls to the working-age population suggest only a limited upside for core PCE price index inflation.

Consensus views on employment and industrial production favor a continuation of the Great Underutilization. Unless payrolls zoom ahead of recent forecasts, the midpoint for fed funds may finish 2017 no higher than 1.125%, while the 10-year Treasury yield spends most of the year under 2.5%. Only if the demand for US output delivers a big enough upside surprise might a substantially fuller utilization of resources help make America great again.

Inflation is on the way back in the rich world, and that is good news

The Economist says it was telling that Germany, a country with a phobia of rising prices, in the first week of 2017 reported a jump in inflation. Its headline rate rose from 0.8% to 1.7% in December.

After two years of unusually low price pressures, inflation across the rich world is set to revive this year. Much of this is because of the oil price, which fell below $30 a barrel in the early months of 2016 but has recently risen above $50 (see chart). Underlying inflation, too, seems poised to drift up. That is good news. The story for 2017 is not of inflation running too hot but rather of a welcome easing of fears of deflation.

To understand why, consider the three big drivers of inflation in the rich world: the price of imports, capacity pressures in the domestic economy and the public’s expectations. Start with imported inflation. A year ago, global goods prices were falling because of a slide in aggregate demand and a seemingly endless glut of basic commodities and manufactures. China’s economy wobbled. Emerging markets in general were in a funk; two of the largest, Brazil and Russia, were deep in recession.

Things look perkier now. Emerging markets still have plenty of trouble spots, but the bigger economies are stabilising. After falling for 54 months, producer prices in China are climbing at last. Prices at the factory gate rose by 5.5% in the year to December. China’s supply glut, though still vast, is shrinking. An improving demand climate is reflected in upbeat surveys of manufacturing purchasing managers across Asia and in the rich world. It is also visible in a revival in commodity prices.

So rich countries are importing a bit more globally made inflation. How big an impact that has depends on the exchange rate. And in much of the rich world, currency markets are proving helpful. In America, where underlying inflation is close to 2%, the Federal Reserve’s goal, the dollar has risen. In Japan and the euro area, where underlying inflation is lower (see chart), the yen and euro have weakened.

The second big influence on inflation is the amount of slack (or spare capacity) in the domestic economy. The unemployment rate, measuring labour-market slack, is often a convenient gauge. On that basis, America’s economy, with unemployment at 4.7%, is close to full capacity. Average wages rose by 2.9% in the year to December, the highest rate since 2009. Assuming that trend productivity growth is around 1%, then wage growth of around 3% is consistent with a 2% rise in unit-wage costs, in line with the Fed’s inflation target.

The picture is cloudier in other parts of the rich world. Euro-area jobs markets are more rigid and run into bottlenecks more readily than America’s. Even so, the euro-area economy has far greater slack. The unemployment rate is 9.8%. The big southern euro-zone economies, such as Italy and Spain, have ample spare capacity. So if inflation is to get back to the European Central Bank’s target of close to 2%, it will require other economies, notably Germany, to generate inflation rates well above 2%.

That is not as implausible as the form book suggests. Germany has a tight labour market. The unemployment rate is just 4.1% and the workforce has shrunk as the population ages. And after a decade or more of restraint, wages have picked up a bit. Compensation per employee has risen at an average annual rate of 2.5% since 2010, according to the OECD, a rich-country think-tank. That is faster than in any other G7 country, but still not enough to drive German inflation up to the sorts of levels needed to push euro-zone inflation close to 2%. Faster wage growth has not fed through to higher consumer-price inflation, notes Ralf Preusser of Bank of America Merrill Lynch. Average core inflation has been around 1.1% since 2010. German firms have absorbed rising wage costs without increasing prices. In Japan, where the jobs market is even tighter, wage growth has struggled to reach even 1%.

That wages have not risen faster owes much to the third big determinant of inflation—expectations. Firms will feel freer to push up prices, and employees to bargain for bigger wage rises, if they expect higher inflation. In theory expectations are in the gift of central banks. If they can convince the public that they have the tools to regulate aggregate demand, and thus the level of slack, expectations should converge on the central bank’s inflation target, usually 2% in rich countries. But expectations are also influenced by what inflation has been recently. In rich countries, it has fallen short. Inflation expectations in financial markets have recently perked up, but in the euro area are still well shy of the target (see chart). In Japan, two decades of deflation have taught firms and wage-earners to expect a lot less than 2%.

Put the pieces of the jigsaw together and the following picture emerges. Headline inflation in the rich world is likely to rise quickly in early 2017, thanks largely to rising oil prices and a generally firmer global backdrop. Underlying inflation will grind up more slowly as above-trend growth eats away at available slack. A burst of stronger headline inflation this year might drive up inflation expectations and set the stage for bolder wage claims in northern Europe and Japan in 2018.

Analysts at JPMorgan Chase expect higher inflation to add one percentage point to global nominal GDP in 2017, spurring a revival in profits and setting the scene for a recovery in capital spending (even without tax cuts in America). Forecasters often now look for extreme outcomes, but rich-world inflation this year may turn out to be a tale of moderation: enough to grease the wheels, but not enough to upset the cart.

We need to find new ways to measure the Australian labour force

From The Conversation.

Over the last few years, we’ve seen a massive shift in the way we work. Thousands of Australians have abandoned the traditional 40-hour work week to work fewer hours or take on ad-hoc work, such as driving for Uber or doing odd jobs on Airtasker.

But the way we measure the labour market has not kept up. We still rely on the Australian Bureau of Statistics’ labour force survey, a survey from the 1960s conducted according to international conventions that is no longer appropriate for today’s labour market.

Today’s economy – one of independent contractors, ad-hoc work, irregular and flexible hours – needs a new form of measurement.

How the government measures the workforce

Every month the Australian Bureau of Statistics (ABS) surveys about 0.32% of the civilian population aged over 15 years about their employment status.

In short, you’re counted as employed if you completed at least one hour of paid work in the week before the survey.

But this doesn’t sound quite right. Clearly, one hour of paid work per week doesn’t fit most people’s idea of employment.

In fact, over one million workers are counted as “underemployed”, meaning they would work more hours if they could. This raises the question of whether these people should really be considered “employed”. The answer depends on what policy question you are trying to address.

Is our unemployment rate right?

Let’s get right into how our unemployment rate is calculated.

If respondents haven’t done any paid work in the last week, they are asked two further questions – first, have they actively sought work in the last four weeks, and second, are they currently available to start work? They are only considered unemployed if they answer yes to both of these questions. Otherwise, they’re not counted as part of the labour force.

This means full-time homemakers, carers, the ill and non-working retirees aren’t considered unemployed.

The labour force is the sum of the employed and the unemployed. The unemployment rate is the percentage of the labour force who are unemployed.

Lastly, the participation rate is the percentage of the population aged 15 and older who are in the labour force. According to the latest ABS trend estimates, the participation rate stood at 64.5% in November, no change from October.

The participation rate has been consistently trending upwards over time for women and falling for men. This does not mean women are increasingly doing more work but that over time they have switched from unpaid to paid work. One of the main reasons for falling participation among men is that unskilled manual jobs for older men have been declining over several decades and many men have been reclassified as unemployed, disabled or retired.

More issues with the survey

The Labour Force Survey only provides a measure of employment and not the number of jobs. For example, a person might work 20 hours per week at a supermarket and 10 hours per week as an Uber driver. Employment is always classified according to the “main job”, so the ABS deems them as one person employed part-time (working fewer than 35 hours) in the retail industry.

If that person worked five more hours as an Uber driver the next week, they would be classified as full-time (35 hours) but the supermarket job would still determine the industry in which they are employed.

The crucial problem here is that there are two jobs being done, but the ABS employment estimate only counts one. So be wary of commentators and politicians making statements like “the economy gained/lost 10,000 jobs last month”! What jobs are they measuring?

The labour force survey also fails to make distinctions between different types of workers. About two million Australians work as independent contractors like construction workers or other business operators such as hairdressers working from home. However, in the figures they are not distinguished from regular employees.

Whereas it might be relatively easy for an employee to know if they did any paid work in the week before the survey, it might not be so obvious for a non-employee. For instance, an author might work 50 hours on their book one week and three hours the next. Most of their work is basic research rather than writing. They receive a royalty payment twice a year. How would they answer the question of whether they did any paid work in the last week?

For non-employees the question of whether they are prepared to start work and have been actively looking for work can also be complex. Someone doing consultancy work might not actively look for work because clients seek them out instead.

We need something new

The ABS has tried tackling some of these issues by conducting some different surveys, including the Characteristics of Employment Survey which presents information on all employed persons according to their status of employment. However, the framework classifies jobholders by their main job. That is, only the job in which they usually worked the most hours. This doesn’t capture many of the issues of concern in, say, the “sharing” or “gig” economy

The ABS has also attempted to compare the number of filled jobs to the amount of employed people, using estimates in the labour force survey. This can reveal interesting information about the labour market. For instance, in February 2013 there were 11,628,300 employed people in Australia, but an estimated 12,287,200 filled jobs. That is, there were 658,900 more filled jobs than there were employed people.

But even then, the estimates still use the conventional definition of a job.

The ABS is still working on an Australian Labour Market Account, based on International Labor Organisation (ILO) methodology, which may address some of the issues discussed here. But this will still be based on traditional definitions of jobs, employment, and unemployment.

Our conventional employment measures are no longer equipped to inform us about important aspects of our labour force and a reliance on them could lead to inappropriate policy. We need labour force numbers than can capture the nuances of a modern economy.

Are the rich really getting poorer and the poor getting richer?

From The UK Conversation.

The median UK household is better off. The poorest households are doing even better than the median, and the richest households have been the greatest losers. At least that’s one way to read the headline statistics put out by the Office for National Statistics (ONS) on January 10 in a new report on household disposable income and inequality.

Yet exactly the same statistics could have been reported in a very different way. In fact, while the poorer 90% of UK households have seen their equality of income improve, all these households are now receiving less in real terms because of the fall in the value of the pound, and this report says nothing about the best-off 10% of households.

Let’s take the three groups, the average, the poorest, and the richest, one by one.

The average household

Does the median UK household now really have more disposal income than a year earlier? Here, the dates being compared are the financial year up to April 2016 compared with the financial year ending in April 2015. According to the ONS, that median disposal income is now £26,300, compared to £25,700 a year earlier. The government statisticians say this is the case after they have accounted for inflation and changes to household composition.

The disposable income being described by the ONS is income after taxes have been paid and benefits have been received – but it is before housing costs have been deducted. So where rent and the cost of buying a home has risen those rises are not been taken into account.

Average UK house prices rose by 8.2% in the year to April 2016. Rents have been rising by similar amounts and fewer young couples are setting up home. If this housing crisis means that fewer grown-up children are able to leave home, household composition would alter and the average household would look a little better off overall because that grown-up child might well have an income.

The poorest households

The incomes of the country’s poorest households – in the bottom fifth of the income distribution – have increased. This is because unemployment has fallen and even very low-paid work pays more than most benefits (if you can get enough hours). However, the reason unemployment has fallen in recent years is because of the most draconian application of benefit sanctions ever applied in the history of the UK.

In 2013, over one million people were sanctioned, losing benefits that amounted to more than all the fines handed out by sheriff’s courts in Scotland and magistrates courts in England and Wales for all the actual crimes committed that year.

What the imposition of sanctions at unprecedented rates showed was that it is possible to reduce unemployment by taking away benefits. To survive, people are forced to take any work that they can possibly find, or move in with relatives or with anyone that will give up a sofa.

This employment growth has resulted in the apparent disposable income of the median household in the worse-off fifth of households appearing to rise by £700 a year, or just over £13 a week. However, for those households in which an extra adult is now working, the cost of actually getting to work every day, of the clothing needed for that work, and the loss in time to care for others (such as children) will be more than that £13 weekly rise.

The richest households

At the same time, the ONS reports that the median income for the best-off fifth of households fell by £1,000 last year. But crucially, this is their median income, and the incomes of the better-off half of all those households are ignored. There is actually greater income inequality in the best-off fifth than between all the other 80% of households put together. Within the best-off tenth, inequalities are huge, with the top 1% of households receiving roughly the same income as the next 9%.

Information on changes to national insurance contributions and child benefit payments, have shown us that most people in the best-off tenth will not have fared well either. But other statistics on the incomes of some of the very best-off (such as top paid bankers) also reveal that those in the very richest 1% have done well over this period.

The number of British bankers paid over a million Euros a year rose from 3,178 to 3,865 in 2014. There is no reason to believe that has reduced. In fact, preliminary figures for 2015 revealed that 971 people working in just four of the large US banks in London received more than a million Euros in pay in 2015, with 11 working for Goldman Sachs getting more than 5m Euros each.

For the poorer 90% of households in the UK, with total household incomes below £53,448 a year, economic inequalities are falling. But they are falling because the people who are poorest are being forced into work that they would not do if they had any choice. They are falling because benefits such as child benefit are no longer universal (top rate tax payers no longer qualify). Or possibly because it is harder and harder for young adults to leave the family home and statistical adjustments for household composition are not sophisticated enough to account for such changes.

Most people are not really financially better-off, other than a tiny proportion of the population in the top 1% who are not even included in these statistics. Most people becoming a little more equal (while a few become very much better off) – as living costs are about to rise even further due to inflation – is not a good news story.

Author: Danny Dorling, Halford Mackinder Professor of Geography, University of Oxford