Experience can be misleading

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A major issue in this elec­tion cam­paign has been expe­ri­ence. Both par­ties accept that expe­ri­ence as an eco­nom­ic man­ag­er mat­ters, and Howard and Costel­lo regard it as their one trump card.But expe­ri­ence can be mis­lead­ing if it teach­es a rote set of behav­iours, and then cir­cum­stances sud­den­ly change. The coloni­sa­tion of Aus­tralia almost failed because farm­ers used their expe­ri­ence in Eng­land and Ire­land to guide their farm­ing prac­tices in Syd­ney. The colony only sur­vived because ulti­mate­ly it adapt­ed its farm­ing prac­tices to this new land (and because it received some help from Indone­sia) .

The rote behav­iours that expe­ri­ence has taught our eco­nom­ic man­agers could prob­a­bly be rolled off the tongue by any pet­shop galah, to bor­row a phrase from Paul Keat­ing: “keep the bud­get in sur­plus; keep infla­tion low; and under­take micro­eco­nom­ic reform”. But at least the first two could be the equiv­a­lent of sewing Syd­ney crops in May, if seri­ous eco­nom­ic change comes our way.

That change has to arrive one day, because a trend that has under­pinned the econ­o­my for the last four decades must ulti­mate­ly reverse. The expe­ri­ence that estab­lished those three eco­nom­ic mantras was gained as pri­vate debt rose from 25 per­cent of GDP when Harold Holt was Trea­sur­er, to 160 per­cent today.

As debt has risen, so has our depen­dence on yet more debt to sus­tain demand. Just as it is for a fam­i­ly, aggre­gate spend­ing in the econ­o­my is the sum of income plus the change in debt. When Holt went for his fate­ful swim, ris­ing debt made only a mar­gin­al con­tri­bu­tion: the increase in debt that year added a only bil­lion dol­lars in spend­ing pow­er to our $28 bil­lion GDP.

Now, it is cru­cial. Last year, the increase in pri­vate debt added $240 bil­lion in spend­ing pow­er to our one tril­lion dol­lar GDP (thank­ful­ly, for the first time in over a decade, busi­ness­es bor­rowed more than house­holds, so at least some of that debt may turn into pro­duc­tive assets one day). Our nation­al reliance on ris­ing debt has to stop someday–just as it must for a fam­i­ly. Then, debt’s con­tri­bu­tion to will either cease, or turn neg­a­tive as Aus­tralians cur­tail spend­ing to pay down their debt.

Pick­ing when that will hap­pen is impossible–you can’t pre­dict when bor­row­ers will decide that they’ve tak­en on too much debt, when spec­u­la­tors will en masse decide that house prices aren’t going to rise any more, or when lenders will decide that too many bor­row­ers are unlike­ly to repay. But when it does hap­pen, the eco­nom­ic land­scape will shift sub­stan­tial­ly-and so should eco­nom­ic pol­i­cy.

If the change is as severe as it was for Japan in 1990, when its 1980s boom col­lapsed into a debt-defla­tion, then the first two mantras become eco­nom­ic mad­ness rather than good sense. In a depressed econ­o­my, gov­ern­ment deficits help keep indebt­ed indi­vid­u­als sol­vent, while infla­tion helps reduce the bur­den of debt repay­ment. Above all else, defla­tion must be avoid­ed, because that com­pounds the prob­lem of exces­sive debt.

Japan passed the first test of good eco­nom­ic man­age­ment dur­ing a debt-defla­tion, but failed the sec­ond: whole­sale prices have fall­en for most of the last 15 years. Hope­ful­ly we can avoid Japan’s fate, but if we can’t, we need eco­nom­ic man­agers who can “think out­side the square”.

We need flex­i­bil­i­ty, not rigid adher­ence to mantras defined by a dif­fer­ent set of cir­cum­stances. I can’t say which Par­ty will be more flex­i­ble, but what con­cerns me is that both are get­ting ready to crit­i­cise the oth­er for aban­don­ing those two mantras–when that may be pre­cise­ly what “good eco­nom­ic man­age­ment” may require.

In a day or so I’ll be pub­lish­ing a pod­cast, cour­tesy of the good graces of Stu­art Cameron. Hope­ful­ly the ink will be up by Thurs­day.

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.