In some ways the policies Labor took to the last election were the most progressive policies it has adopted for years. But in other ways Labor policies conformed to economic orthodoxy. For example:
- the federal government’s budget should return to surplus as soon as possible;
- in order to be economically responsible, all new spending programs must be fully funded by tax revenue.
The Coalition is generally regarded as more economically responsible than Labor. Accordingly, in the recent election, Labor went to great lengths to portray itself as more economically responsible than the Coalition. It attempted to do this by promising a bigger budget surplus earlier.
In its budget plan Labor promised to:
- Deliver a budget surplus in 2019-20, the same year as the Government.
- Deliver budget surpluses over the forward estimates more than 40 per cent larger than the Government, and bigger surpluses over the medium-term.
- Deliver strong surpluses of one per cent of GDP by 2022-23, four years earlier than the current Government trajectory.
- Use the $87 billion in bigger surpluses over the medium term to pay down more debt.
- Make $154 billion in savings through reducing concessions and handouts to the top end of town and redirects the funding to better services.
But was this really economically responsible? The economy was weakening before the election. This weakening has resulted in the Reserve Bank cutting interest rates since the election. The Reserve Bank conspicuously avoided a rate cut during the election campaign. But the economic weakening was already underway. In the lead up to the election Chris Bowen referred to the desirability of a larger, earlier, surplus so as to provide a bigger economic buffer for the economy in the event of a downturn. But in the aftermath of the election Labor has already called for the Coalition’s stage 2 tax cuts to be brought forward because the economy needs a stimulus. But not that much changed in the economic fundamentals over the last two months.
According to economist Stephen Hail the economically responsible position in the circumstances would be a stimulatory budget with a deficit of $50-60 billion. While Hail viewed Labor’s policies on negative gearing and franking credits as worthy in themselves, he didn’t see them as necessary in order to fund it’s spending initiatives:
“…the opposition chose to pick a fight about franking credits. Don’t get me wrong, there is an argument to be made for the proposed changes and a stronger argument for changes to capital gains tax and negative gearing. But given the current economic circumstances in Australia, this was a fight they didn’t need to have.”
Of course had Labor chosen to promise a stimulatory budget without promising a surplus it would still have faced a scare campaign. But instead of focussing on new taxes, the scare campaign would have focussed on alleged irresponsibility of a budget deficit.
We can assume Labor will always face a scare campaign. Indeed Labor expected one in this election. But it believed the scare campaign on tax changes could be demolished because the negative gearing changes were grandfathered and the franking credits would only affect a small segment of the population. It is always easy to speak with the benefit of hindsight. But Labor appears to have fatally underestimated the extent to which the scare campaign would succeed in convincing enough voters that Labor’s measures went further than they actually would have.
Maybe this was the election when Labor should have run a small target, or smaller target, campaign? But it might generally be harder for a reformist party like Labor to fall into power by “default”, with a small target campaign, than for the Coalition. Each of Labor’s ‘change of government’ victories in 1972, 1983 and 2007 had an ‘It’s Time’ element to them. But they were also led by opposition leaders who were popular, articulate and had a substantial policy agenda.
There are at least two potential problems for Labor with a small target strategy. The first is you might not get elected anyway, especially if the current government has not suffered major divisions or scandals and you don’t have policies to sufficiently differentiate yourself. While the Coalition suffered major divisions in the last term of government, these seem far less likely in the next term. Second, if you win on a small target, your mandate is constrained. This second factor is another reason why small target is more of a problem for Labor than the Coalition because the Coalition does not really want to do much in government apart from let the market rip.
In any event, the issue for Labor is not really whether there will be a scare campaign. The issue is more likely to be on which terrain is a scare campaign most likely to be successfully dispatched? A reformist party like Labor will always wish to spend more on targeted programs that promote equality and social justice. It will always have to answer the question but how can you afford it? So Labor will either have somehow convince voters to accept changes to the tax system to fund these spending initiatives, or else it will have to change the prevalent community view that such spending invariably requires either higher taxes or unsustainable budget deficits.
Taxes and scare campaigns
In ‘Three Long Years’ I argue that in politics there are issues in politics which change votes of some people but not most. I give the example of jumps horse racing. If surveyed 90% of people will say jumps racing should be banned. But very few will care enough to change their vote on this issue. Who will change their vote? Everybody who is directly involved in the industry- trainers, jockeys, owners and any of their friends that they can convince.
It seems that, for similar reasons, making fundamental changes to the tax system is perilous terrain for scare campaigns. The 2019 election campaign is just the latest example. There is also Paul Keating’s successful 1993 campaign against the GST proposed by John Hewson. His line “If you don’t understand it, don’t vote for it” was as effective as the Coalition’s attack line in this election: “It’s the Bill Australia can’t afford”.
Fundamental tax reform is even difficult from within government. Most of the Henry review’s reform proposals gather dust on the book shelf. The one proposal the Rudd government did try to implement from Henry’s recommendations, the mining industry resource rent tax, was substantially whittled away by the Gillard government following the mining industry’s scare campaign. It was subsequently abolished altogether by Tony Abbott. Tellingly, Labor did not dare argue for its reestablishment in the 2019 election.
The one exception was John Howard’s successful advocacy of a GST ahead of the 1998 federal election. Howard and Costello had carefully tried to lay the groundwork for the reform before hand. Even then it was a close run thing. Kim Beazley polled more votes than Howard in the 1998 election. But Howard won votes in the right places.
Budget deficit and scare campaigns
A Newspoll conducted in April 2018 found that the most preferred options for the federal budget among those surveyed was as follows:
|Cut individual tax rates||15||17||15|
|Reduce debt and deficit||26||41||14|
|Increase school funding||12||5||19|
|Increase spending on health||27||19||34|
|Increase infrastructure spending||15||15||14|
This poll would seem to indicate that Labor would not have a major problem with its own political base if it ran a budget deficit in order to finance spending initiatives. Liberal-National party voters place a higher priority on reducing debt and deficit. The poll does not tell us what more working class voters who supported One Nation or Palmer’s United Australia Party and gave preferences to the Coalition might think about debt and deficit reduction.
But these poll figures also reflect a public opinion that is presumably conditioned by the constant refrain from both major parties about the importance of reduction of the debt and budget deficit, the constant equating of government debt with household debt and the constant propagation of the notion that government debt is something that is “owed” to the government by the citizenry. All of these assumptions are challenged by Modern Monetary Theory (MMT). There is a raging debate over MMT in the USA. But it barely figures on the Australian political radar.
MMT will form a basis of Bernie Sander’s platform for the US Democratic Party presidential primary campaign. One of Sanders main economic advisers, Stephanie Kelton, is an advocate of MMT. Other economists that are prominent supporters of MMT or its close cousin, sovereign money, include Warren Mosler, L Randell Wray, Martin Wolf and Australians Bill Mitchell and Stephen Hail.
MMT is really a way of demystifying money. We already live in a monetary world. MMT is not a policy that has to be “adopted”. It is an alternative narrative which challenges the myth that money is in short supply when the real issue is spending priorities. Right wing governments have no issue creating new money to pay for war, or tax cuts for high income earners, or to bail out banks but falsely claim money is in short supply when it comes to progressive social spending.
Labor needs to consider the elements of MMT narrative that it should adopt if it wishes to avoid scare campaigns around the tax and spend platform it adopted in the 2019 election. There will of course be scare campaigns around MMT as well and advocacy of MMT necessarily involves changing the way citizens think about money. But with the right political strategy a scare campaign against MMT policies might be less effective than one directed against new taxes.
The points below set out the basic ideas of MMT. These points aim to explain its approach. If Labor incorporated elements of MMT in its policies, consideration would need to be given to the messaging associated with the approach. How can the approach be explained in a way that is convincing to enough voters? The narrative around MMT has nothing to do with any spending initiatives themselves. But messaging around MMT necessarily comes into play in answer to the inevitable question “But how will you pay for it?”
Modern monetary theory (MMT)
MMT is a collection of ideas. Not all proponents of MMT necessarily agree with each other on every policy that falls under its umbrella. MMT is however neatly and concisely explained in this short video.
MMT is supported by the emerging left of the Democratic Party in the USA. It is the response to critics who ask how will Democrats fund programs such as the Green New Deal, the job guarantee and Medicare for all.
The assumptions of MMT may include the following:
- Government creates new money when it spends into the economy. Far from creating a debt in the citizenry government deficits create a surplus of money for non-government participants in the economy. The only constraint on government spending should be inflation. If the total amount of new money exceeds the productive capacity of the economy to produce enough goods and services to absorb it, inflation results. This is because too much money is chasing too few goods and services resulting in demand push inflation.
- Taxes do not provide some pool of money that government then dips into to fund its spending. It’s not “tax and spend”; it’s “spend and then tax.” That’s the sequence.
- Government spending stimulates economic activity resulting in greater taxation revenues. (Stephanie Kelton). Taxes are needed to withdraw money from the economy to prevent inflation and to promote socially desired goals, for example, reducing inequality or providing incentives against deleterious behaviour, like smoking or carbon pollution.
- Government budgets are not like either household or private business budgets. Both households and private businesses understandably want to avoid too much debt. Households need to earn money to meet living expenses. Private business need to earn profits to pay dividends to shareholders. But government does not need to ‘earn’ money. A currency issuing government, like Australia’s, has the power to create new money through minting dollars and coins and though digital spending.
- Dollars the government spends into the economy are taken by people and businesses in that economy. This is why the financial sector/commercial bankers hate government spending. When governments spend there is more money circulating in the economy so citizens and businesses are less likely to need to borrow from banks. Citizens’ indebtedness to private banks grows in inverse relation to the government deficit. Too little government deficit makes for too much citizens’ debt. This is why “austerity” policies are ridiculous, self-defeating, and immensely harmful. (Stephen Hail, Stephanie Kelton)
- Unlike households and private businesses, as a currency creator which does not borrow in foreign currency, and with a central bank that sets interest rates, governments like that of the Australian government cannot go bankrupt. The position of governments that do not issue their own currency are more susceptible to retaliation from the bond market through which they must raise funds. (Bill Mitchell)
- A currency issuing government does not need to issue debt (government bonds) to “balance” spending. The bond market is basically corporate welfare. The purchase of government bonds gives the private sector a guaranteed risk free annuity at the expense of government which can issue currency rather than borrow to fund spending. (Bill Mitchell)
- The orthodox economics conviction that inflationary pressures build too much once unemployment gets below 4-6% is wrong (Stephanie Kelton). Too much saving results in unemployment. People who are against public sector debt typically encourage savings which leads to unemployment and need for public sector spending/debt. (Mosler)
- A major aim of fiscal policy should be spending to ensure full employment. The private sector generally prefers not to employ unemployed people. They prefer to employ persons already in employment. Government should provide a job guarantee to all unemployed at least as an interim measure for them to transition to employment in private sector. Wages for this work should be set at the minimum rate payable in the private sector for such work. If all unemployed turned up and just dug a hole would be better than current system- but there is multitude of useful jobs that can be done. Full employment is the measure of government having spent enough so that all potential capacity in the economy is being utilised. (Mitchell, Mosher).
- Fiscal policy (level of government spending) is a more effective than monetary policy (interest rates) in affecting demand levels in the economy. In a slump, cutting interest rates is a less important factor than depressed expectations of profits. In a boom, raising interest rates does little to quell new activity, and higher rates could even support the expansion via the interest income channel. (Kelton)
- All spending can potentially cause inflation, not just government spending. The crucial issue is whether spending matches the productive capacity of the economy. (Mitchell)
- The threat of inflation and hyper-inflation from government using its currency issuing power to spend into the economy is much exaggerated. The two examples most often cited are Germany’s Weimar Republic between 1921-23 and Zimbabwe under Mugabe which peaked in 2008. In both of these cases the fundamental cause of the hyper inflation was destruction of the productive capacity of the two economies, which in Germany’s case was accompanied by the requirement to pay unaffordable reparations. Inflation/hyper inflation does result when government spending occurs in a context where the economy cannot produce enough goods and services to absorb the money government puts into the economy.
- Government deficits were created by Ronald Reagan to finance his tax cuts and in the wake of the global financial crisis. Reliable estimates are that the US Federal Reserve intervened to the tune of $29 trillion in the wake of the GFC. Most of this money went to bailing out banks. The money could have been better spent by directing more of the spending to consumers. But the deficits themselves have not had significant negative effects or resulted in hyper-inflation. (Kelton).
- While Republicans criticise MMT theory the current behaviour of the Trump administration is consistent with the theory. Trump increased the budget deficit from 3.4% of GDP in 2017 to 5.1% 9n 2019. It has spent upwards of $1.5 trillion on tax cuts and $300 billion on other spending which aims to increase growth by 3%. The spending has not been well targeted, with more of the money being spent on share buy backs than long term investment. Democrats would spend in a different way. But this does not alter the fact that the Trump administration has adopted a fiscally expansionary policy. (Kelson)
- After the GFC bad loans meant banks in England as elsewhere stopped lending. The Bank of England therefore created 445 billion pounds of new money ( called “quantative easing”). But instead of spending the money direct into the economy it gave the money to the private banks too lend. Most of the leading went to property or the share market with only about 7% of lending being made into the real economy. (Sovereign Money)
Positive Money, a UK research and lobby group, support an additional policy not necessarily shared by all MMT proponents. They emphasise that not only government but also private banks create new money in the economy. Private banks do this when they make loans. People typically imagine that banks lend out money they hold on deposit but typically they are only required to hold around 10% in reserves. They create new money out of thin air by computer entry into the borrowers account. This new money is created as private debt upon which interest must be paid to the bank.
The more radical position of Positive Money is their concept of ‘Sovereign Money’ under which only government would be able to create new money in the economy. Citizens would be able to deposit money in a central government bank which would offer low rates of interest but would be guaranteed by government. Accounts with private banks would offer higher rates of interest but would not be guaranteed by government.
MMT differs from Positive Money insofar as none of MMT’s proposals entail ending new money creation by private banks. However, along with Post-Keynesians, some MMT figures recommend restrictions on the sort of trading that banks can engage in.
In this video Richard Werner, speaking at a conference of the Money Institute, confirms Positive Money’s position on how banks create new money in the economy (credit creation theory). But, unlike Positive Money, Werner supports a continuation of this decentralised model of new money creation. However he calls for regulation so that the creation of new money by private banks is restricted to loans to productive parts of the economy rather than loans that operate to inflate asset and share prices.
Positive Money and economist Martin Wolf also point out that seigniorage is non- taxation government revenue representing the difference between the value of money and the cost to produce it. Seigniorage creates revenue for government without it having to collect taxes. In the 2016-17 Australian federal budget, seigniorage was listed as an “other source of non-taxation revenue”. It only raised $107 million. But this only what is collected on government production of notes and coins. Martin Wolf estimates the value of capturing seignorage on digital money created by private banks at 4% of GDP. Nicholas Gruen, CEO of Lateral Economics, calculates this would be worth $70 billion for Australia.
Criticisms of MMT
Criticism of MMT comes from orthodox economists, including orthodox Keynesians, such as Paul Krugman.
The main criticism relates to the danger of inflation. The argument goes like this- It is true that a currency issuing government can create as much money as it likes but the value of money depends on it having some scarcity. Society needs people to work. If money is not in sufficiently scarce supply they won’t. You do not want money to actually be too scarce. But you want it to be perceived as scarce.
There is also doctrine, even among among mainstream Keynesian economists such a Paul Krugman, holding that: (1) government deficits push interest rates higher and (2) rising interest rates crowd out private investment. The government can take more of the economy’s financial resources, but only at the expense of lost private investment. This means that running budget deficits has at least some downside.
In this article Stephanie Kelton responds to Paul Krugman’s criticisms and queries about MMT.
Jayadev and Mason from the Institute for New Economic Thinking suggest that the real objection to MMT from more mainstream economics lies in a political concern more than a difference in economic theory. Unless they are concerned with balancing budgets, elected government with the power to create new money can never be trusted to exercise sufficient constraint in money spent into the economy so as to avoid inflation. They state:
“What reason do we have to believe that an elected government that is free to set the budget balance at whatever level is consistent with price stability and full employment would actually do so? This is where the real resistance lies.”
Other left critics say MMT underrates the difficulties involved with funding programs such as the Green New Deal and job guarantee by “postponing’ the issue of tax increases. While it is true that government can fund these programs with a keystroke before it raises taxes, MMT proponents have not addressed the possible effects on investment, exchange rates, and economic growth. Plus inflationary pressure is likely which would then have to result in either increased taxation and/or increased interest rates in order to reduce aggregate demand, so this issue should be addressed up front.
Continuing to adhere to economic orthodoxy
Continuing to adhere to the economic orthodoxies around government spending and reducing the budget deficit might ultimately prove successful for Labor. These orthodoxies are not necessarily inconsistent with the type of mainstream Keynesian economic stimulus package delivered by the Rudd government in response to the GFC.
The Rudd economic stimulus package meant Australia was the only OECD economy to avoid a technical recession as a result of the GFC. In the event of a further global recession, which will come sooner or later, and possibly sooner, the Morrison Government may copy the austerity policies that failed so badly in Europe.
More likely however, Morrison will adopt a milder version of economic stimulus, consistent with the Coalition’s criticism of the Rudd package, which was that, while stimulus was justified in response to the GFC, the spending package was too big and costly.
In fact the Coalition is already offering an economic stimulus. But its primary mechanism for doing so is tax cuts. This includes its stage 3 tax cuts which would see an inegalitarian 30% top marginal rate on all incomes between $40,000 and $200,000. Labor is yet to decide if it will oppose stage 3.
If economic conditions continue to weaken and the Coalition imposes austerity (cuts to health, education and the like), or fails to provide a sufficiently large or effective stimulus, it may be punished by the electorate and the “default” election victory expected in May 2019 might come about in 2022. But I wouldn’t be betting on it.
In any event, sooner or later Labor will likely have to consider the issues raised by MMT. The next global recession is but one possible catalyst.