As the treasurer lauds supply-side economics, a once-controversial recovery theory is gaining traction. By Mike Seccombe.

Could Frydenberg ease this crisis by printing money?

Treasurer Josh Frydenberg.
Treasurer Josh Frydenberg.
Credit: Sam Mooy / Getty Images

Perhaps Josh Frydenberg was just trying to nettle the government’s critics with his repeated assertions that his response to Australia’s coronavirus-induced economic crisis will be inspired by the policies of Margaret Thatcher and Ronald Reagan.

Certainly, a smile played about the treasurer’s lips last Sunday on the ABC’s Insiders as he spruiked – for the second time, following earlier comments at the National Press Club – the records of the pair, and declared them to be “figures of hate for the left because they were so successful”.

If he intended to wind up people, it worked. Opposition Leader Anthony Albanese said the spectre of a Thatcher–Reaganite response would send a “shudder down the spine” of every Australian worker. A raft of progressive commentators offered similar critiques.

The alternative, though, is that Frydenberg was serious.

And the concern there is that the economic problems Thatcher and Reagan faced 40 years ago are fundamentally different to those lacerating Australia and countries around the world.

Frydenberg lauded Thatcher for taking on and defeating militant unions. “She came in, she reduced the number of days lost to industrial disputation from 30 million down to two million,” the treasurer said.

But today, the urgent problem in the labour market is not workers going on strike but workers continuing to work when they shouldn’t because they can’t afford not to.

The union movement has been warning since March – publicly and in meetings with the government – that unless these workers were given sick leave in response to the epidemic, the disease would spread. Only this week did the Fair Work Commission heed the message and grant such leave to workers in aged-care facilities. The government is belatedly talking to the unions about broader provision of sick leave to casual workers, but some say it’s many deaths too late.

The treasurer also offered praise to Reagan and Thatcher for having triumphed over the great economic malaise of their time – “stagflation” – the combination of high inflation and stagnant economic growth.

Again, the question is one of relevance. Inflation is not the problem now; it’s the opposite. The latest data from the Australian Bureau of Statistics, released on Wednesday, showed consumer prices down 1.9 per cent in the three months to June, the biggest quarterly fall in 72 years. Australia’s annual inflation was negative 0.3 per cent.

While a few unusual factors contributed to this deflation – the ABS noted temporary free childcare, and falls in the cost of petrol and preschool and primary education – the figures are still dire.

This bodes ill for what will happen when the changes to the government’s JobKeeper and JobSeeker programs come into effect at the end of next month.

Once a country enters a deflationary cycle, it is very hard to get out.

When prices start to drop, consumers are apt to delay spending in the belief goods and services will be cheaper in the future, which in turn renders the price drop inevitable. Businesses then cut back on investment, production and employment.

In his other praise for Thatcher and Reagan – lauding them as creators of jobs – Frydenberg was simply incorrect.

In May 1979, when Thatcher was elected, the unemployment rate in Britain was 5.3 per cent. Under her government’s aggressively austere policies, joblessness immediately zoomed upwards. Data from Britain’s Office for National Statistics show it peaked at 11.9 per cent in the second quarter of 1984. In working-class areas of Northern Ireland, northern England and Scotland particularly, rates were about 20 per cent.

Thatcherism also hacked away at the social safety net – “there is no such thing as society”, she famously said – and radically redistributed income and wealth upwards, through tax cuts for high-income earners. The tax rate for the highest earners went from 83 to 40 per cent. At the same time, according to the independent and respected Institute for Fiscal Studies, the poverty rate jumped from 13.4 to 22.2 per cent during her tenure.

And what of our treasurer’s other hero, Ronald Reagan?

Frydenberg claimed that by “cutting taxes, cutting red tape, he created 20 million new jobs”.

Actually, this overstates the reality by about 25 per cent. According to figures from the US Federal Reserve, there were about 16.1 million new jobs created in Reagan’s eight years, mostly low paid. During the same period, the US population grew by nearly 22 million. Unemployment averaged 7.44 per cent during the Reagan presidency – well above the postwar average.

While he wasn’t able to achieve the slate of tax-cutting objectives he came into office with, the top personal tax rate was slashed from 70 per cent to 28 per cent. He also slashed corporate taxes.

The basic tenet of Thatcher and Reagan’s trickle-down economics is that if government reduces taxes on businesses and wealthy individuals, they will spend the extra money left in their pockets on improving productivity, creating new jobs and growing the economy.

But there is little evidence that lowering taxes is particularly effective in “growing the pie”, as they say – a point forcefully made by one of the pre-eminent experts on inequality, Professor Emmanuel Saez, in a lecture to a gathering of economists in San Francisco in December 2015.

When Saez, his long-time collaborator Thomas Piketty and others analysed the economic performance of more than two dozen nations, they found, he said: “There is no clear correlation between cuts in top tax rates since the 1960s and growth in gross domestic product (GDP) per capita since the 1960s.”

That is to say, reducing taxes does not increase economic growth. Furthermore, said Saez: “High top tax rates reduce the pre-tax income gap without … having a clear negative effect on economic growth.”

The other consequence of the adoption of supply-side economics was that it reduced government revenue.

Economic commentator Alan Kohler believes the intent of the main proponent of supply-side theory in the 1970s, economist Milton Friedman, was to starve government of funds. Friedman was a key policy adviser to both Thatcher and Reagan.

“He didn’t trust politicians,” says Kohler. “He was the initiator of the Reagan dictum … [that] the government is not the solution to the problem; it is the problem.”

Kohler says that in his embrace of “small government, neoliberal ideas … in that mistake” Friedman has “poisoned economics and policy for decades”.

Kohler is hardly part of the group Frydenberg sees as the hateful left. He is very much in the mainstream, which recognises the importance of government to a well-functioning society and economy.

“The question,” says Kohler, “is how much should you take out while putting back?”

He personally is a fan of the Scandinavian countries, where the government tax take is high – up to about half of GDP, twice what it is in this country – and high marginal tax rates are imposed on the wealthy.

But the optimal rate of taxation is a vexed question. At a tax rate of zero, government would get no revenue and society would collapse, but at a tax rate of 100 per cent, government would get no revenue either, because no one would work, and society would also collapse. Somewhere between those extremes is a sweet spot.

By pointing out this obvious fact to Republican politicians at a famous meeting in 1974, a conservative economist named Arthur Laffer not only won enormous influence but gave cover for tax policies that benefited the rich.

Give the wealthy more, Laffer said, and all will ultimately benefit.

Despite all evidence to the contrary, Laffer continues to peddle his line. About five years ago, on a tour of this country, sponsored by the Australian Chamber of Commerce and Industry, he did the rounds of Canberra. Josh Frydenberg tweeted a picture of himself with Laffer, grinning and gripping.

And apparently Frydenberg still believes in Laffer’s prescription. At his press club address last week, he trumpeted the same neoliberal remedies, including tax cuts, as the way out of our current economic difficulties.

“When we put in place tax cuts or business incentives or try to cut red tape or go to the supply side of the equation, that’s going to be critical,” he said. “It is important to go to the supply side. Thatcher, Reagan – that’s an inspiration. Supply side can actually help create and strengthen the economy and that is what we are determined to do.”

But John Quiggin, a professor of economics at the University of Queensland, says the idea that lower taxes will work in the current circumstances is “ludicrous”, and the fact that Frydenberg continues to recite the trickle-down dogma shows he is “not up to the job”.

Recovering from the Covid-19 crisis will be like the task of recovering from World War II, he says, when government was far more directly engaged in job creation. It will be very, very expensive. Yet the government argues it simply cannot afford to keep spending as it has in the past few months.

Which prompts the question: could the government run out of money?

And the answer to that, says Bill Mitchell, a professor of economics at the University of Newcastle, is a resounding no.

“I believe the government has no such financial constraints,” says Mitchell.

For decades, Mitchell has advocated modern monetary theory (MMT) – he even gave the economic proposition its name. But for a long time, his was a voice in the wilderness. Now, with governments the world over facing stalling economies, rising unemployment and no more interest rate cuts left to make, MMT is having something of a moment.

In this country, it has found an eclectic collection of supporters: Alan Kohler is one, as is Indigenous leader Noel Pearson, for whom it brought the realisation that high unemployment is essentially a political decision.

In the United States, MMT is endorsed by the progressive wing of the Democratic party as integral to the Green New Deal, by the likes of Bernie Sanders and Alexandria Ocasio-Cortez. A book on the subject by economist and Sanders adviser Professor Stephanie Kelton, The Deficit Myth, recently became an international bestseller.

Writing recently for The New York Times, Kelton outlined how MMT rejects the neoliberal idea that large government deficits are a bad thing and cutting your way to surplus is prudent fiscal policy.

“Prime Minister Margaret Thatcher of Britain – President Ronald Reagan’s partner in the conservative revolution of the late 20th century – captured these sentiments in a seminal speech in 1983, declaring that ‘the state has no source of money other than the money people earn themselves. If the state wishes to spend more, it can only do so by borrowing your savings or by taxing you more,’ ” she wrote.

“That thinking sounds reasonable to people, including me when I first absorbed it. But Mrs Thatcher’s articulation of the deficit myth concealed a crucial reality: the monetary power of a currency-issuing government.”

This is the essence of the theory – that government budgeting is nothing like household or business budgeting, for the simple reason that government can create money.

Says Mitchell: “The government spends by the Department of Treasury instructing the Department of Finance to instruct the Reserve Bank of Australia to type numbers into bank accounts on its behalf. That’s how they spend. It comes from keystrokes on computers going into virtual systems.”

No doubt this money creation must be done carefully. If a government creates too much, the result is inflation, which, as any number of examples from the Weimar Republic in Germany to Robert Mugabe’s Zimbabwe show, can quickly spiral out of control.

The constraints on money creation, says Mitchell, “are real resource constraints”. Government cannot generate money to compete for resources that are already being used, only for unused resources.

If that seems hard to grasp, consider an example. Assume an economy working at full capacity, with full employment. If a government were to decide it wanted to spend money hiring people to work on a new program, it would have to hire them away from whoever was already employing them, which would bid up market prices for their labour. But if that government hired people who were unemployed, that wouldn’t happen.

There’s nothing political in this basic understanding, says Mitchell: MMT is really just a “lens through which you can understand the [economic] system much more clearly”.

But what follows from understanding MMT is definitely political, which is that government could expand to take up any slack in the economy – anathema to the small government brigade.

You could, says Mitchell, “introduce an unconditional job offer at a socially inclusive minimum wage to any workers that wanted to work”.

“So, there’s no need for the unemployment rate to rise to 10 per cent. I could drop the unemployment right down to 2 per cent, easily.”

Mitchell calls this the “job guarantee”. Modelling recently released by him and colleagues at the University of Newcastle’s Centre of Full Employment and Equity suggests reducing unemployment from 10 per cent to 4 per cent would require a net investment of $51.7 billion yearly. The total cost would depend on how long it took to beat the virus and get private sector employment going strongly enough to take up the slack.

In one study, Mitchell and colleagues contacted 140 local governments around Australia, asking them to nominate programs that would “meet unmet community need, unmet environmental care need and unmet infrastructure need”.

The responses identified jobs, “hundreds of thousands” of them, that could be done, if only the money were there to pay for them.

Of course, this would require politicians to take back control of money supply from central banks – a controversial prospect, given the nature of our politics. And for MMT to function as hypothesised, our elected officials would need to spend this money on worthwhile endeavours.

It’s no surprise then that MMT has its critics on the left, as well as the right, including many traditional Keynesians who would stimulate economic activity by the usual means of borrowing money that is accessible at incredibly low rates of interest. Bill Gates has called the theory “crazy talk”. Others worry about Mitchell’s view that this would obviate the need for a welfare system, or that conservatives will use the fact that government can create money as another excuse for lower taxes.

Yet while the idea of saving the economy simply by printing money might sound a bit like alchemy, it is gaining adherents. Whether MMT is the way out of the current, wicked economic problem, this much is certain: no answers to the present employment and economic crises are to be found in the records of Reagan and Thatcher.

This article was first published in the print edition of The Saturday Paper on August 1, 2020 as "Could Frydenberg ease this crisis by printing money?".

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