Take note, Turnbull Government.

Infrastructure, not tax cuts.

As predicted, tax cuts are not driving wages. Even if you believed they would, it wouldn’t have happened for many years.

Wage rises we’ve recently seen would have happened anyway with an economy so close to full employment. And there’s no sign of an investment boom either (the very thing needed to drive wages even in the long term).

The tax cut is just driving share buybacks, which send gains to (mostly wealthy) investors, not wages.

So as promised, it will worsen inequality and still worsen the budget position.

https://aneconomicreality.blogspot.com.au/2017/12/corporate-taxes-revisited.html

https://www.nytimes.com/2018/03/25/opinion/tax-cuts-and-wages-redux-slightly-wonkish.html

We'll take them!

Trump is threatening one of the US's key strengths. And Australia could pick up the slack.

International students are turning away from the US
One of the US's key exports and competitive advantages - education - may be under threat.

International student enrolments in the US had trended upwards for a long time, with the exception of a temporary dip following 9-11. But new data has shown enrolments recently fell almost 4% from 840,160 to 808,640 - with almost half of this decline coming from a fall in Indian students in science and engineering.

And Trump's Muslim ban and attempts to halve legal immigration are likely culprits, with two of the top reasons reported for the drop being "feeling unwelcome in the United States" and visa issues. Trump also wants to take away the ability of spouses to work while waiting for green cards, and pass a new rule that makes it harder for international students to work in the US in the months after they graduate. He is also reportedly considering restrictions on Chinese visas.

To be fair, there are other reasons international students may be turning away from the US - mass shootings, reports of campus rape, even the recent devaluation of the Indian currency.

But all of this bodes poorly for one of the US's key economic advantages.

Welcome to the Land Down Under!
Maybe this fall in the US is something upon which Victoria (and Australia more generally) can capitalise. Education is already Australia's third largest export. And Victoria, Australia's 'education state', lost a significant share of Indian students following the GFC (as I wrote about here).

Chinese students are also the most significant share of Victoria's international students (over 30%) - an advantage upon which we may be able to build in light of the US's less than welcoming persona.

It used to be that "when the US sneezes, Australia catches a cold". But in this case, the US is sneezing and Australia might have all the Codral.

So which is it, Mr President? Trade surplus or gold standard?

Because you can't have both.

Trade is not a zero sum game.
The gold standard does not create stability.
Mercantilism and the gold standard are dangerous ideas by themselves. They certainly don't mix.



IDEAS OF ECONOMICS PAST
It seems the Trump administration is filling will relics of economic prehistory - mercantilists and gold bugs. Both are discredited ideas. But even worse, they are mutually exclusive.

Mercantilism asserts that international trade is a zero sum game of winners and losers. When we trade, your gain is my loss, and my gain is your loss. Therefore, a country should seek to export as much as possible, and import as little as possible, thereby running a large trade surplus.

And gold bugs have an affinity with the 'good old days' when countries operated on the gold standard. The argument goes that by fixing the exchange rate to a finite commodity like gold, it will bring stability, rather than the volatility inherent in flexible exchange rates of the modern world.

And when you combine these arguments, a country's success is measured by the size of its trade surplus and the accumulation of precious metals (gold) that consequently flow into the country.

Both Trump and his trade advisor Peter Navarro are guilty of the mercantilist fallacy (although, as Catherine Rampell aptly put it, "to be fair even ... 18th century mercantilists knew to slap tariffs on finished goods, not inputs"). During Trump's campaign, he also spoke of how 'great' it would be for the US to return to the gold standard. And the under secretary of Treasury for international affairs, David Malpass, said in 2011 that the US should raise interest rates to strengthen the US dollar (to a level at which it probably would have been under a gold standard).



WHAT'S WRONG WITH THESE IDEAS?
Where to begin ...

Trade is not a zero sum game, it's a positive sum game where both sides of the bargain have the potential to win. The buyer gets the goods or services, and the seller gets paid. Do you feel like you've 'lost' when you buy a burger from your local shop, simply because the shopkeeper didn't buy something from you in return? Does this 'trade deficit' with the local shopkeeper make you angry? No. Because a trade deficit is not necessarily a bad thing when you both get something. Win-win.

Consequently, a country's wealth is not measured by its ability to sell to other countries more than it buys. It's measured by the degree to which it specialises in the production of goods and services that it is good at producing - a process that is facilitated by international trade, not hindered.

To reinforce the stupidity of the mercantilist view, it was discredited by Adam Smith's Wealth of Nations in 1776 - almost 250 years ago!

As for the gold standard, it does not create stability. International volatility doesn't just disappear when you fix the exchange rate. Rather, it must subsequently be absorbed by the inflation and unemployment rates. This is what would have happened back in 2011 if David Malpass had his way - unemployment was still at 9% and higher interest rates to maintain a stronger exchange rate was the last thing the country needed. A flexible exchange rate that absorbs international shocks so that the Central Bank can stabilise unemployment and inflation is infinitely preferable to an economy that swings from depression to boom, an inflation rate that swings between -5% and +20%, and an unemployment rate that swings between 2% and 25% (not precise numbers, but valid for the point of comparison).



WHY THESE IDEAS DON'T MIX
Now for the true stupidity - that these mercantilists and gold bugs currently occupy the same White House.

Under a gold standard, when a country runs a trade surplus (as per the mercantilist view), it causes gold to flow into the country, which is then 'sterilised' by the Central Bank printing more money. This drives up inflation, thereby making the country marginally less internationally competitive, causing exports to fall, imports to rise, and gold to flow back out of the country, thereby returning the trade balance to zero.

Conversely, a trade deficit results in gold outflows, deflation, improved competitiveness and a return of gold until the trade balance once again is zero.

See the problem here? One can not simultaneously maintain a trade surplus and a gold standard if the game is played fairly. Of course, when gold flows into a country, they could hoard it instead of sterilising it with new money creation. This would maintain an artificially strong exchange rate and a trade surplus while on the gold standard.

Of course, that would be cheating, because that country's trading partners would be forced to maintain trade deficits to sustain the cheating country's surplus. And if they weren't happy about that and decided to retaliate, run their own surpluses, raise interest rates to attract gold back to them, which they would then hoard, and refrain from printing money themselves, we get a little something called the Great Depression.

Moreover, Trump himself criticised China for doing just that in the past - except instead of hoarding their own currency, China hoarded foreign currency to artificially undervalue their exchange rate to support their export industries at the expense of their trading partners (including the US). China stopped doing this before Trump even announced his presidential candidacy. But Trump didn't get that memo, and actually tried to take credit for China stopping its currency undervaluation. And now he's surrounding himself with people who want to break the exact rules he bemoaned China for breaking?

And even to the extent that a gold standard would relieve any trade deficit (if a permanent trade surplus weren't the objective), once again, it would do so via wild swings in inflation and unemployment - volatility that causes much more damage and hardship to human lives than a volatile exchange rate. And not something that would make Trump look good. As WJ Ashley (a 19th century protectionist, but still a voice well-respected by the other side) once said:

"All observers of working-class life will agree that a period of low wages and of partial or complete unemployment has a negative and degrading effect, far greater than the positive elevating effect of a period of high wages and overtime."

These ideas are truly destructive by themselves. To try to combine them in the 21st Century, with all the history we now have, truly beggars belief.

Is there no one left in this administration with even the slightest understanding of economic theory or history?

Monash University public lecture - artificial intelligence and the future of work.

A.K.A the day I disagreed with a Lord.

This week I attended a lecture presented by Lord Meghnad Desai.

Lord Desai was fascinating to hear and has an incredible CV: Chairman of the Meghnad Desai Academy, renowned academic, Professor Emeritus at the London School of Economics, a member of the EU Financial Affairs Sub-Committee, a life peer of the British House of Lords, and Chairman of the Gandhi Statue Memorial Trust.

Which is why I hesitate to challenge him.

Will machines fully replace humans?

One of his positions seemed to be that artificial intelligence (AI) will never replace humans fully in the workplace because it'll never have our capacity for creative thinking. Routine predictable manual labour, sure. But it'll never be able to adapt to unforeseen circumstances to which it wasn’t programmed to adapt. In the end, it'll always be limited to the intelligence of the one who programmed it.

So as long as there’s always unforeseen circumstances (or "uncertainty", to use the economics terminology), there’ll be jobs.

One example Lord Desai gave is in health care. In the next 20 years, it is estimated that 40% of the workforce will be in health care - increasingly in mental health, which is harder to deal with than physical health and can only be done by humans. People will always demand one-on-one attention for medicine (education too). Machines simply can’t do it.

Now for my boldness ... I disagree.

Isn’t it just a matter of programming the machine to self-program (i.e. learn)? To figure out unanticipated problems for itself based on its programmed knowledge - just like humans?

The human brain is essentially a computer literally limited to the genes (programming) of our parents. But we still have the ability to adapt to circumstances that our parents never faced. Why can’t machines, that are limited to the programming we give them, adapt to circumstances we never faced?

The mind wanders.

If machines do replace us, what's left for humans?

But Lord Desai did offer an olive branch to the alternative view, and a ray of hope. For those worried about what will happen to the human condition in a future without work - when many people define their lives and their very humanity by their work - Lord Desai offered a very simple idea:

"No economic activity can be sustained alone by supply. You need demand."

Even in an idealised world where AI has eliminated all human effort, that is not the end of life. The only limitation is the amount of tax that can be extracted and reallocated to people to generate the demand necessary to meet this newly automated supply.

Filling our spare time with sufficient leisure will be the least of our problems.

Here were some other great quotes/thoughts from Lord Desai during the evening:

• Economics’ greatest strength is solving problems that don’t exist.
• This is an economics lecture, let’s not worry about reality.
• He even told a joke: A man robs bank, drives away, and as he’s crossing a bridge, he’s stopped by the police. He confesses to robbing the bank only to be told by the police that he was only pulled over because he was the millionth person to cross the bridge and had won a prize.
  Now he’s in jail. He decides to never let such a thing happen to him again. So he builds a probability machine that predicts perfectly accurately what will happen in the next 5 minutes. It works. But it tells him he will die in the next 5 minutes. So he destroys the machine and commits suicide.
  Moral: even when we can predict the future, we can’t always control it.

Let Trump get away with it.

Why we shouldn't retaliate against Trump's tariffs.

• We could easily punish the US for Trump's tariffs.
• But it will hurt us too.
• Let his own people tear him apart.
• Because he will never admit to being beaten by another country.

I recently wrote about Trump’s aluminium and steel tariffs, and the potential for the rest of us to retaliate with our own tariffs, launching an all-out trade war which everyone will lose.

If we retaliate against Trump with our own tariffs, it probably will damage the US. But it will also hurt our countries too, by increasing the price of whichever US export on which we've just imposed a tariff (e.g. consumer goods for households, production inputs for businesses, etc.). Whatever we place tariffs on will become more expensive for us in the hope that it will damage the US and cause Trump to rethink his position - like a normal president would.

But Trump is no normal president. In this kind of contest, Trump will never admit to being wrong. After all his bluster about how the rest of us are taking advantage of the US, he will never admit that we beat him. He would scorch the entire Earth if it meant he could be king of the graveyard.

So retaliating will hurt everyone, us included, and will only make Trump dig his heals in more.

Which is why we should - and this is the part that requires some serious pride swallowing - let him get away with it.

These tariffs alone are bad, but not a disaster. But if we retaliate, the potential subsequent trade war could easily escalate beyond anyone’s expectations, causing serious pain and hardship the world over - even global recession. And that can happen even when there are reasonable people in charge.

Also, fortunately for us, Trump’s tariffs will hurt the US too. Industries such as automotive and other manufacturing (the typical “real” American blue collar industries Trump fantasises about) rely on foreign steel as an input. And tariffs on inputs can have multiplied adverse impacts on the final goods for which these inputs are used, far greater than the initial tariff. So this tariff will make the US suffer, without the need for the rest of us to retaliate.

It’s very likely Trump has no idea about this, especially given the fact his trade adviser Peter Navarro, recently said this:

“My function, really, as an economist is to try to provide the underlying analytics that confirm his intuition.”

So Trump doesn’t have people around him providing independent economic advice. He has propagandists and 'yes men'. But the manufacturers that suffer from this misstep will surely be loud about it. And these are the sorts of people (if any) to whom Trump will listen. Traditional business and industry Trump can remember from his childhood in the 1950s. And removing the tariff because these industries asked him won’t feel like losing or backing down for Trump. He likes them. But backing down in the face of international retaliation will feel like losing.

Trump’s tariffs won’t bring the US steel industry back in any big way so manufacturers will still have to import steel, now more expensively. We should let his own people tear him apart because of these tariffs. We shouldn’t force our people to suffer from our retaliation in the hopes it will make Trump see reason.

He’s not that kind of president.

Innovation Policy in Australia: Never a Better Time?

I attended the Grattan Institute event “Innovation Policy in Australia: Never a Better Time?” at the State Library tonight. Interesting discussion. Here were a few of the key insights:

• Australia is not a top tier innovation country. Tertiary education is our third highest export but we struggle to translate R&D into commercialisation. Better links between universities and business would help. 
• Trends towards renewables and recycling will undermine our key exports of coal and iron ore. And new frontiers takes decades of development and investment. Just look at the best case scenarios of the Asian Tigers - their advantages still took decades to develop.
• We can’t just piggyback off the rest of the world’s innovation: profit is higher for first movers over early adopters (e.g. Apple iPhone vs Samsung Galaxy); we need to innovate to even understand how others’ innovations work; and a lot of problems that require innovation are often peculiar to Australia (e.g. Hendra virus) so no one else will innovate for us.
• Australia gives very little funding to industry R&D compared to the OECD.
• Before WWII, universities weren’t even officially recognised as research institutions. After, official KPIs encouraged further research in universities. Only recently have they been encouraged to engage more with industry too.
• In light of expected trends in automation, there is scope (in addition to education and corporate incentives) to improve the social welfare state for individuals to account for increased structural unemployment and to reduce the fear of failure associated with risk taking, entrepreneurship and innovation?

Paul Krugman Q&A on Trump's tariffs.

Paul Krugman, given his expertise in international trade, is taking public questions in light of Trump's recent tariff announcements.

Here were some questions I sent through:

1. Is there anything to the claims that the US is the victim of dumping, and in such a case, would the WTO be effective enough to stop it without the need for the US to take unilateral action?

2. With so many Republicans claiming to be fans of the free market, would they gain anything by revisiting the teachings of Adam Smith - a man they supposedly adore but who actually defined national wealth as driven by the division of labour (facilitated by trade), rather than by the accumulation of precious metals (from merely exporting rather than importing, thereby running only trade surpluses), as was the previous logic? Or would a greater focus on Adam Smith do more harm than good?

3. If the US were to go down the protectionist route and ‘pick winners’, as per the infant industry argument, clearly aluminium and steel don’t qualify. Do any other industries qualify?

4. Could temporary support (tariff, subsidy or other) be justified as a way to slow down (not reverse) the demise of a non-competitive industry and ease the pain of that structural unemployment, even if it temporarily diverts resources from productive uses and gives an unfair advantage over foreign exporters?

5. Under what circumstances would national security be a real reason for tariffs? Adam Smith for example, said "As defence … is of much more importance than opulence, the Act of Navigation is, perhaps, the wisest of all the commercial regulations of England", despite not being favourable to foreign commerce.

October Sky

Trump recently tweeted:

"We must protect our country and our workers. Our steel industry is in bad shape. IF YOU DON’T HAVE STEEL, YOU DON’T HAVE A COUNTRY!"

This reminded me of the father from October Sky, when talking to his son Homer about the US space race:

Father - "Well, tell me something, Homer. Uh, what exactly is this Wernher von Braun...and the rest of those Germans accomplishin' anyway? 'Cause if you ask me, it's nothin' but a stunt ... When the novelty wears off, they're all gonna be sent packin'. Maybe then they'll have to find themselves a real job."

Homer - "Like minin' coal?"

Father - "You listen here. The coal we mine makes steel, Homer. And if steel fails, this country fails. If you had half a damn brain in your head, you'd know that."

It seems Trump doesn't realise that the greatest achievements of the last 60 years were by people looking FORWARD from the 1950s, not backward.

Don't do it, Donald!

It won't help and you won't win.

US steel and aluminium are not infant industries.
The rest of the world will retaliate.
This is not temporary transition support.
Nor is it a justified anti-dumping measure.
It is protectionism that will spark a trade war that everyone will lose - plain and simple.

Donald Trump announced last Thursday that he would impose a 25% tariff on steel imports and 10% on aluminium.

I wrote about the prospect of Trump protectionism (Trumponomics) over a year ago, specifically some exceptions to the rules of free trade where protectionism may be justified - the infant industry argument; market power; and temporary transition support.

Let us review, shall we?

First, US steel and aluminium are not infant industries that can't afford private finance but will be able to 'pay back' this support once they have matured. Rather, they are mature and declining industries that would be able to obtain private finance if they had any long term potential. If Trump is trying to pick winners, he shouldn't pick losers.

Second, other countries are indeed considering retaliation that even the US's market power won't be able to absorb. Canada "will take responsive measures to defend itself" which could, for example, target agricultural exports and/or withdraw from NAFTA negotiations that Trump has been so keen to do. The EU (which is actually a bigger player than the US in terms of global trade) also is considering "swift, firm and decisive" retaliation on politically sensitive US exports like Kentucky bourbon and Wisconsin dairy products (two states that voted for Trump and would be particularly loud about his failure to protect them), as well as Harley Davidsons and bluejeans. Even if other countries would be better off letting Trump get away with this (their retaliatory tariffs will, after all, hurt their own people as well as the US), politics and national pride don't make for the most rational decision makers.

And many projections are predicting higher prices for US consumers and producers despite this market power. This includes the auto industry which relies on imported steel. And just in case you wanted more to show that any benefits to US industry would be outweighed by costs to industry, the stock market (you know, the thing that is literally a measure of expected future company profits) dropped 500 points on Trump's announcement.

As for temporarily supporting a declining industry to cushion the impact of this decline, this is what Trump said to industry regarding the announcement:

"We're going to build our steel industry back and we're going to build our [aluminium] industry back ... And you'll have protection for a long time in a while. You'll have to regrow your industries, that's all I'm asking."

Does that sound like temporary transition support? What other industries will he deem worthy of support before he realises that this new protectionism has got out of hand?

There is an additional exception to free trade that I didn't mention last time - dumping. This occurs where a foreign country (perhaps unintentionally) produces far more of a particular product than they can sell in their own country so, to obtain at least something for it, they sell it below cost in the export market. Trump has accused China of doing this. And theoretically, given China's size, they could put US industry out of business just with their 'overflow'. And there would be no guarantee that China would continue to supply this product to the US if their domestic industry were to disappear - let alone at these 'dumped' prices.

Ironically, Britain was upset at the US in the 19th century for just this - dumping of manufactured goods on the export market when there was a temporary domestic glut in the US, putting pressure on already-struggling British manufacturers. In fact, it also drove a similar protectionist movement in Britain at the time which, luckily, didn't actually result in a trade war.

But if Chinese dumping were the primary concern, Trump's tariffs would target only China, not the whole world. Furthermore, Canada is the largest steel exporter to the US. China doesn't even crack the top 10. This isn't an anti-dumping measure; it is blatant across-the-board protectionism.

And I haven't even mentioned the questionable logic that says this protectionism will help any US industries at all. Firstly, steel and aluminium in the US have become highly automated. US iron and steel mills produce essentially the same output they did 30 years ago, but employ just 86,000 workers, compared to 188,000 then. Any boost to this industry won't suddenly reverse these employment losses - it would be new investment in plant and equipment. And if foreign investment is needed to finance these expansions (which is likely), the benefits from this may not even accrue much to the US at all.

As for the aluminum industry jobs that have been lost overseas, they have not largely gone to China. They have gone to places like Iceland, Canada and Norway, where an energy-intensive industry like aluminium can obtain cheap geothermal or hydropower. These tariffs won't bring either industry back, but they very well may send manufacturers who depend on aluminium and steel as an input overseas.

Those hurt by the declining steel and aluminum industries absolutely deserve support. But giving them false hope is cruel. Not only will these tariffs not help those people, they will hurt everyone else.

Make no mistake, this trade war really will make everyone worse off - the US included.