Cutting taxes for the wealthy is the worst possible response to this economic crisis

John Quiggin, The University of Queensland

Australia’s response to the health and economic impacts of the COVID-19 pandemic is rightly considered one of the world’s best. At their best, our federal and state politicians have put aside the sterile games dominating politics for decades.

It seemed possible these efforts might last, as politicians sought to find common ground and make real progress on issues such as climate change, industrial relations and inequality as part of the coronavirus recovery.

But as soon as the virus seemed to be receding, politics returned to the old “normal”. Policies are again being put forward on the basis of ideological reflexes rather than an analysis of the required response to our new situation.

There is no more striking example than the federal government’s reported plan to bring forward income tax cuts legislated for 2024-25. The idea apparently has backbench support.

Those cuts will benefit high-income earners the most. They include replacing the 32.5% marginal tax rate on incomes between A$45,000 and A$120,000, and the 37% rate on incomes between AA$180,000, with a single 30% rate up to A$200,000.

This is being proposed while the government begins to wind back income-support measures, such as free child care, with much more serious “cliffs” fast approaching.

This economic crisis is different

One of the most striking features of Australia’s initial response to COVID-19 was the speed at which the Morrison government abandoned a decade of rhetoric denouncing the Rudd Labor government’s response to the Global Financial Crisis.

In mid-March the government was floating the idea of a tightly limited response with a budget of A$5 billion. By the end of the month this had been abandoned in favour of the JobSeeker and JobKeeper schemes, estimated to cost A$14 billion and A$70 billion respectively. Other schemes brought the total to A$133 billion.

Despite the close resemblance to the Rudd stimulus packages, there was one crucial difference.

The GFC caused a collapse in the availability of credit, potentially choking off consumer demand and private investment. This was the classic case needing demand stimulus.

By contrast, the COVID-19 pandemic caused a shock to the production side of the economy, which flowed through to incomes. Millions of workers in industries such as tourism, hospitality and the arts were no longer able to work because of the virus.

The crucial problem was to support the incomes of those thrown out of work, and keep the businesses employing them afloat until some kind of normality returned. There were problems with the details of eligibility and implementation of the JobSeeker and JobKeeper programs, but the response was essentially right.

Have cash, will buy luxury car

The primary rationale for early tax cuts is that they will stimulate demand. But the economy’s real problem is not inadequate demand – particularly not on the part of high-income earners.

On the contrary, the problem for high-income earners is having a steady income even as many of the things they usually spend on (high-end restaurant meals, interstate and overseas holidays) have become unobtainable.

Among the results has been a splurge on luxury cars. Compared to June 2019, sales of Mazdas, Hyundais, Mitsubishis, Kias, Nissans and Hondas last month were all down. But Mercedes-Benz, BMW, Audi and Lexus were all up.

As Jason Murphy notes, this rush to buy fancy cars isn’t definitive proof the wealthy are looking to ways to spend all the money they’re saving. “But it is suggestive. Eventually the money has to go somewhere.”

The worst possible course of action

The continuing problem with the pandemic is the loss of income faced by millions of workers. By definition, anyone in a position to benefit from a high-end tax cut doesn’t have this problem. Equity would suggest that, far from receiving more income, they should be sharing more of the burden, if not now then in the recovery period.

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When the federal government legislated its tax-cut schedule in advance, critics including Reserve Bank governor Philip Lowe and Access Economics partner Chris Richardson pointed out the danger of promising future tax cuts based on projected growth. The same policy had failed ignominiously in the 1990s when the Keating government legislated tax cuts to be introduced after the 1993 election. After declaring the cuts “L-A-W”, Paul Keating was forced to withdraw half of the tax cuts when the budget deteriorated.

These criticisms have now been vindicated.

The decade of strong economic growth, starting this year, that was supposed to make big tax cuts affordable has disappeared. We will be lucky if per capita GDP is back to its 2019 levels by 2024-25, when the tax cuts are slated to kick in regardless of circumstances.

Once that happens, we will need all the tax revenue we can get to bring the budget back into balance and deal with the continuing expenditure needs the pandemic has created.

The government now seems to be headed for the worst possible course of action – cutting support for those hit hardest by the pandemic while pouring money into the bank accounts of the well-off.

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The inevitable result of such a policy will be a surge of personal and business bankruptcies, mortgage defaults and evictions. That will bring about the kind of demand-deficiency recession the tax cuts are supposed to prevent, superimposed on the continuing constraints created by the pandemic.

So far we have all been in this together. For high-income earners that means forgoing tax cuts promised in happier times and contributing more to the relief of those who need it most.

John Quiggin, Professor, School of Economics, The University of Queensland

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Government to inject economic stimulus by accelerating infrastructure spend

Michelle Grattan, University of Canberra

The government is responding to increasing concern about the faltering economy by accelerating A$3.8 billion of infrastructure investment into the next four years, including $1.8 billion for the current and next financial years.

Scott Morrison will outline the infrastructure move in a speech to the Business Council of Australia on Wednesday night, while insisting the government is not panicking about Australia’s economic conditions.

The government’s action follows increasing calls for some stimulus, with concern the tax cuts have not flowed through strongly enough to spending.

The just-released minutes of the last Reserve Bank meeting show the bank seriously considered another rate cut at its November meeting but held off, partly because it thought that might not have the desired effect. Reserve Bank governor Philip Lowe has previously urged more spending on infrastructure.

Morrison is making appearances in various states to publicise the government’s infrastructure plans.

The infrastructure bring-forward over the coming 18 months is $1.27 billion plus $510 million in extra funding. Over the forward estimates, the bring-forward is $2.72 billion plus $1.06 billion in additional funding.

The government’s latest action means since the election it will have injected an extra $9.5 billion into the economy for 2019-20 and 2020-21. This comprises $7.2 billion in tax relief, $1.8 billion in infrastructure bring-forwards and additional projects, and $550 million in drought assistance to communities.

In his BCA speech, draft extracts of which have been released, Morrison is expected to say that “a panicked reaction to contemporary challenges would amount to a serious misdiagnosis of our economic situation”.

“A responsible and sensible government does not run the country as if it is constantly at DEFCON1 the whole time, whether on the economy or any other issue. It deals with issues practically and soberly.”

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He will say that notwithstanding the headwinds, including the drought which has cut farm production, the economy has continued to grow, and is forecast to “gradually pick up from here” with jobs growth remaining solid.

“Against this backdrop, it would be reckless to discard the disciplined policy framework that has steered us through many difficult periods, most recently and most significantly the end of the mining investment boom, which posed an even greater threat to our economy than the GFC.”

The projected return to surplus this financial year would be a “significant achievement”.

Lauding the government’s legislated tax relief, Morrison will say. “Our response to the economic challenges our nation faces has been a structural investment in Australian aspiration, backed by responsible economic management.”

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Morrison’s infrastructure bring-forwards follow his post election approach to the states asking for projects that could be accelerated.

As a result of this process we have been able to bring forward $3.8 billion of investment into the next four years, including $1.8 billion to be spent this year and next year alone.

This will support the economy in two ways – by accelerating construction activity and supporting jobs in the near term and by reaping longer run productivity gains sooner.

Every state and territory will benefit, with significant transport projects to be accelerated in all jurisdictions – all within the context of our $100 billion ten-year infrastructure investment plan.

This bring forward of investment is in addition to the new infrastructure commitments we have made in drought-affected rural communities since the election.

In his address Morrison is also expected to announce the first stages of the government’s latest deregulation agenda, aimed at enabling business investment projects to begin faster.

Michelle Grattan, Professorial Fellow, University of Canberra

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Risk of shooting war with Iran grows after decades of economic warfare by the US

Iranian officials show off the U.S. drone they shot out of the sky.
Meghdad Madadi/Tasnim News Agency

David Cortright, University of Notre Dame

Many are worried about the risk of war between the U.S. and Iran. But the truth is, the U.S. has been fighting with Iran for decades in an economic war waged via sanctions – which is about to get a lot worse.

Concerns about a war of guns, warplanes and missiles grew after Iran shot down a U.S. spy drone amid already worsening tensions. President Donald Trump says he ordered a retaliatory strike in response – only to reverse course at the last minute.

Whether or not a shooting war does break out, the United States’ economic war has already been intensifying over the past year. On June 24, Trump imposed “hard-hitting” new sanctions on Iran in response to the attack on the drone.

Existing sanctions have already devastated innocent Iranians. Not only that, they’ve undermining long-accepted principles of international cooperation and diplomacy, a topic I’ve been researching for the past 25 years.

Carrots and sticks

Many nations have recognized that sanctions work best as tools of persuasion rather than punishment.

Sanctions by themselves rarely succeed in changing the behavior of a targeted state. They are often combined with diplomacy in a carrots-and-sticks bargaining framework designed to achieve negotiated solutions.

Indeed, the offer to lift sanctions can be a persuasive inducement in convincing a targeted regime to alter its policies, as was the case when successful negotiations involving the U.S. and Europe led to the Iran nuclear deal in 2015. That deal ended sanctions in exchange for Tehran shutting down much of its nuclear production capacity.

A year ago Trump withdrew the U.S. from that accord and not only reimposed previous sanctions but added further restrictions, including so-called secondary sanctions that penalize other countries for continuing to trade with Iran.

Protesters hold anti-war signs outside the White House.
AP Photo/Jacquelyn Martin

Multilateral vs unilateral sanctions

In an increasingly globalized world, unilateral sanctions like these – in which one country goes it alone – are rarely effective at achieving their end result, which in this case is regime change.

Multilateral sanctions involving several or many countries have greater impact and make it more difficult for targeted individuals or regimes to find alternative sources of oil or other goods. And getting authorization through the United Nations or regional organizations provides legal and political cover.

When the U.N. Security Council imposed targeted sanctions on Iran in 2006 over its illicit nuclear activities, for example, members of the European Union were able to join the U.S. and other countries in applying pressures that brought Iran to the bargaining table. That’s what led to the negotiated nuclear deal nine years later.

The U.S. circumvented this voluntary multilateral process when it withdrew from the accord and unilaterally imposed “extraterritorial secondary sanction.” These barred nations or companies that buy Iranian oil or other sanctioned products from doing business in the U.S.

Although most countries disagree with the U.S. withdrawal from the Iran deal and some reject such sanctions as an infringement on their own sovereignty, they are powerless. They cannot afford to lose access to dollar financing and the U.S. economy and thus are forced against their will to do Washington’s bidding.

Iranians pay the price

And the Iranian people are paying the price.

Oil exports and national income are dropping, inflation is rising and economic hardships are mounting. The Iranian rial lost more than 60% of its value in the last year, eroding the savings of ordinary Iranians.

Life is becoming increasingly difficult for working families struggling to make ends meet. There are indications that the new sanctions are inhibiting the flow of humanitarian goods and contributing to shortages in specialized medicines to treat ailments such as multiple sclerosis and cancer.

Cargill and other global food giants have halted shipments to Iran because of the lack of available financing.

Punishment of the Iranian people seems to be a deliberate policy. When asked recently how the administration expects sanctions to change the behavior of the Iranian government, Secretary of State Mike Pompeo acknowledged they won’t be able to do that and instead suggested it’s up to the people to “change the government.”

In other words, the pain of sanctions will force people to rise up and overthrow their leaders. This is as naïve as it is cynical. It reflects the long-discredited theory that sanctioned populations will direct their frustrations and anger at national leaders and demand a change in policy or the regime. Sanctions have never worked for this purpose.

The more likely result is the classic “rally around the flag” effect. Iranians are critical of their government’s economic policies, but they also blame Trump for the hardships resulting from sanctions. Governments subjected to sanctions are adept at blaming economic hardships on their external adversaries, as Iran’s religious and elected leaders are doing now against the United States.

Tehran is likely to respond to tightening sanctions by giving greater authority to companies associated with the Iranian Revolutionary Guard Corps, a major branch of the Iranian military, further empowering the very hard-line forces Washington claims to oppose.

The White House is ignoring these realities and adding to the already draconian sanctions, while threatening and making preparations for military strikes, hoping that economic pain and military pressure will make Iran’s leaders cry uncle. There is no sign of surrender yet from Tehran, nor is there likely to be, until the two sides pull back from the brink and agree to negotiate a diplomatic settlement.

This is an updated version of an article originally published on May 23, 2019.

David Cortright, Director of Policy Studies, Kroc Institute for International Peace Studies, University of Notre Dame

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Blocking Huawei’s 5G could isolate Australia from future economic opportunities

Marina Yue Zhang, Swinburne University of Technology

Trade conflict between the US and China has accelerated towards the brink of trade war.

A recent Trump executive order preventing US companies from working with “adversaries” (China fits this description) was hammered home by a ban on selling US high-tech products to Chinese tech company Huawei.

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Australia too has put a halt on 5G infrastructure coming from China.

But this is about more than just which company’s poles and wires will provide internet for your phone and movie downloads in the future.

Choices the US, Australia and other nations make around how they set up 5G will determine how we use technology for collaboration, innovation and global business.

Huawei’s 5G is becoming a global standard

5G is the fifth generation network for mobile connectivity. It has been described as “game changing” due to high speeds and high capacity, and provision of superior service to high numbers of users.

5G relies on standardisation – the technical specifications used in mobile networks – supported by patents and licensing agreements.

In mobile networks, standard essential patents (SEPs) are those patents that any company will have to license when implementing 5G. History suggests companies holding SEPs benefit significantly from royalties.

Data from April 2019 shows China, collectively, owns over one-third of the world’s SEPs for 5G.

China lost its opportunity in 1G and 2G, learned an expensive lesson from its failed 3G standard, and achieved substantial catch-up in 4G. It is determined to lead in 5G.

Chinese tech companies such as Huawei and ZTE understand that transition to 5G opens a window of opportunity for them to achieve this goal. To do this they need to build followers – and momentum is already moving in this regard.

By the end of March 2019, Huawei had reportedly been awarded 40 5G commercial contracts from carriers around the world (including 23 from Europe, six from the Asia Pacific, ten from the Middle East and one from Africa).

The battle of radio spectra

In addition to standardisation, radio spectrum is another critical factor in 5G. Radio spectrum is a limited resource that is used for communications from Earth to space.

Spectrum allocation is at the heart of 5G competition.

Huawei’s 5G technology has been developed for mid-band spectrums which are available for commercial use in many countries, including Australia.

The best plan for Australia is that mid-band solutions be used to cover the bulk of 5G networks, with high-band technologies to provide complementary coverage in densely populated areas.

The US has limited access to mid-band spectrums for commercial 5G, as most in this range are for defence use. So the US developed its 5G technologies for high-band spectrums – which presents that country with a dilemma.

It is not easy for the US to switch from high-band to mid-band 5G in a short time. And it’s not likely the rest of the world will give up using mid-band solutions, which provide wider coverage and require less investment in infrastructure.

A short-term answer is for the US to push its allies to jointly exclude Huawei from their 5G networks. This might be sought to protect the US from 5G “isolation”, and perhaps have other commercial or political implications – or a combination of these factors.

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The consequence is that Australia, as one of those allies, would likely need to spend more money on base stations and the necessary infrastructure and wait a longer time for a fully operational 5G system.

For example, a Huawei 5G base station is only one-third the size of its 4G equivalents and weighs only 20 kilograms: it’s easier to install, and the technology is at least 18 months ahead of its competitors such as Nokia. This advantage is lost if Australia continues to block Huawei.

Australia’s fourth mobile telco, TPG, argues that there is “no credible case” to rollout its 5G as planned without Huawei.

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Fractured globalisation?

5G will support many applications such as industry automation, self-driving cars, massive machine-to-machine communications, internet of things, smart cities and more.

This means the growth of 5G will accelerate development of an ecosystem in which different countries can co-exist and co-develop, supported by interconnected and interdependent supply chain networks.

Such ecosystems are built on mobile network infrastructures, upon which are layered technology platforms for manufacturing, medical treatments and payments (for example) and then applications for working, studying and living.

For example, in the future this sort of system might be used by Australian and Chinese academics and industry experts to work together on innovations related to health care, environmental protection or industrial automation.

But this may fall down if the involved countries build their 5G infrastructures differently.

Australia’s final 5G plan could have profound implications for Australia’s economic development into the future.

Marina Yue Zhang, Associate Professor of Innovation and Entrepreneurship, Swinburne University of Technology

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Vital Signs: Australia’s sudden ultra-low economic growth ought not to have come as surprise

Both Australia’s trend and seasonally adjusted GDP per capita growth rates have dipped below zero.
Shutterstock

Richard Holden, UNSW

Australia’s big little economic lie was laid bare on Wednesday.

National accounts figures show that the Australian economy grew by just 0.2% in the last quarter of 2018. This disappointing result was below market expectations and official forecasts of 0.6%. It put annual growth for the year at just 2.3%.

But the shocking revelation was that Gross Domestic Product per person (a more relevant measure of living standards) actually slipped in the December quarter by 0.2%, on the back of a fall of 0.1% in the September quarter.

These are the first back-to-back quarters of negative GDP per capita growth in 13 years – since 2006.

We’re going backwards, for the first time in 13 years

The reason this is significant is that the Australian convention around what constitutes a recession is two back-to-back quarters of negative GDP growth.

Since more people in the economy mechanically increases overall GDP, you might think that measuring things on a per-person basis gives a better sense of whether we are better off or worse off.

And you would be right. Why then, do we talk so much about overall GDP?

One answer is that in a lot of advanced economies there isn’t very much population growth, so overall GDP is a good enough measure.

Population growth hides it

The more insidious answer in Australia is that, for a long time, our high population growth, fed by a high immigration rate, has masked a much less rosy picture of how we are doing. And neither side of politics has wanted to admit it.

At 1.6% a year, Australia’s population growth is roughly double the OECD average, which is perhaps why we hear politicians say things like “Australia continues to grow faster than all of the G7 nations except the United States,” as Treasurer Josh Frydenberg did this week.

The good news is that standard economic theory tells us that in the long run, immigration has very little impact on GDP per capita in either direction, unless it drives a shift in the population’s mix of skills.

But in the short term, it depresses GDP per capita because fixed capital such as buildings and machines has to be shared between more workers.

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The business lobby doesn’t want us to focus on that because population provides more customers as well as more workers, allowing them to grow without growing domestic market share or exports.

Governments don’t want us to focus on it because adjusting for population growth makes GDP growth look small or, as at present, negative. Also, the tax revenue from the population growth is factored into the official budget forecasts – but the extra social spending needed isn’t always factored in.

Pro tip: watch for population growth as a fudge factor generating a return to surplus in next month’s budget.

There’s a better way of getting at the truth

That said, GDP itself – per capita or not – is not a great measure of the standard of living. That’s why in 2001, the Bureau of Statistics began also reporting real net national disposable income.

It is a measure with advantages over GDP. As the bureau points out, it takes account of changes in the prices of our exports relative to the prices of our imports – our terms of trade. If the prices of our exports were increasing much faster than the prices of our imports (as happened during the mining booms), our standard of living would climb and real net national disposable income would reflect it, where as gross domestic product would not, although it would reflect increased income from increased export volumes.

To get at living standards per person, which is what we are really interested in, the bureau also publishes real net national disposable income per capita.

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The graph shows that so far the growth rate of real net national disposable income per capita hasn’t changed much, and that it has been negative for far fewer quarters than in the Coalition’s first term in office.

It bounces around with changes in the prices of imports and exports, and is generally climbing less than when export prices were really high.

A year of two halves?

The treasurer painted 2018 as a “year of two halves”.

The first half was great – the annualised GDP growth rate (what it would have been had it continued all year) was a very impressive 3.8%.

The second half was just 1%.

I’m not sure the change was that clear cut. As I wrote last September, there have been troubling signs for some time, despite the solid headline growth.

Household savings have been plummeting, real wage growth has been stagnant, housing prices have been falling in Sydney and Melbourne. Together they put significant pressure on household spending, which accounts for about 60% of GDP.

Those concerns are now mainstream. Good news on export prices has rescued tax receipts for the time being, and will probably also rescue real net national disposable income per capita.

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But the fundamentals of the Australian economy are looking somewhat weak. Like the US and other advanced economies, we are living in an era of secular stagnation – a protracted period of much lower growth than we had come to expect.

And until we do something to tackle it, such as a major government investment in physical and social infrastructure, we will continue to face anaemic wage growth, shaky consumer confidence, and mediocre economic growth per person.

Richard Holden, Professor of Economics, UNSW

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Darwin port’s sale is a blueprint for China’s future economic expansion

Darwin Port, leased to Landbridge Industry Australia, a subsidiary of Shandong Landbridge, for 99 years.
John Garrick, CC BY-SA

John Garrick, Charles Darwin University

An agreement between Darwin’s city council and an overseas municipal counterpart normally wouldn’t attract much attention. Local government officials love signing such deals. Darwin already has no less than six “sister city” arrangements, including with the Chinese city of Haikou.

But attention has been drawn to Darwin’s newly minted “friendship” deal with Yuexiu District, in Guangzhou, due to Chinese media describing it as part of President Xi Jinping’s signature Belt and Road Initiative.

This suggests Chinese authorities regard Darwin as having strategic significance.

It invites reflection on the wisdom, three years ago, of the Northern Territory government deciding to lease the Port of Darwin (now known as Darwin Port) to a Chinese company for 99 years – and of the federal government going along with it.

At the time the new owner, billionaire Ye Cheng, claimed the Darwin port deal was “our involvement in One Belt, One Road”. This was discounted by some commentators as hyperbole, an attempt to curry favour with the Chinese government.

But now, by design or not, the Darwin port deal increasingly looks like a blueprint for how Chinese interests can take control of foreign ports – as it is doing by various means around the world – without arousing local opposition. Quite the reverse. All levels of Australian government have encouraged it.

It makes Darwin an interesting case study – a point of contest between the strategies of the US and China. Darwin’s port is under Chinese control, while thousands of US marines are based in the city, as part of the US “Pacific pivot” seen by many as an effort to contain China’s influence in the region.

CC BY-ND

How the port deal was done

The deal to lease parts of the port followed successive federal governments refusing to fund necessary upgrading of the port’s infrastructure to meet growing demand.

Infrastucture Australia advised privatisation. Rather than sell outright, the territory government decided to lease the port, and sell a controlling stake in the port’s operator.

Landbridge Australia, a subsidiary of Shandong Landbridge, won the 99-year lease with its bid of A$506 million in November 2015.

Shandong Landbridge has substantial and varied interests including port logistics and petrochemicals. Though privately owned, like many Chinese companies it has strong ties to the ruling Chinese Communist Party.

The company knows how to cultivate political connections. In Australia it gave influential Liberal Party figure and former trade minister Andrew Robb an $880,000 job just months after he retired from parliament.

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The bid for the port was examined and approved by the Foreign Investments Review Board, the Defence Department and ASIO.

Strategic importance

But the deal put Darwin directly in the crossfire between US and Chinese interests. Then US president Barack Obama expressed concern about the lack of consultation. Former deputy secretary of state Richard Armitage said he was “stunned” that Australia had “blind-sided” its ally.

While the centre of US-Chinese tensions is the South China Sea – where China has militarised reefs in disputed waters – Darwin is important because it is the southern flank of US operations in the Pacific.

Managing the tensions

Zhang Jie, a researcher at the Chinese Academy of Social Sciences, wrote in 2015 about the concept of “first civilian, later military” – in which commercial ports are to be built with the goal of slowly being developed into “strategic support points” – to assist China defending maritime channel security and control key waterways.

Military-civilian integration was among the goals China set in its 13th five-year plan for 2016-20. President Xi subsequently established an integration committee to oversee civilian and military investment in technology.

As with other Chinese port acquisitions, such as in Sri Lanka, Pakistan, Greece and Djibouti, Landbridge is interested in acquiring and developing not only Darwin’s port facilities but nearby waterfront property.

But the Darwin port deal differs in significant ways to other port acquisitions.

It is a far cry from the “debt-trap colonialism” China stands accused of using to gain leverage over other foreign governments, such as Sri Lanka and Nepal.

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Landbridge has bought the lease, rather than a Chinese bank lending funds to the Northern Territory government to develop the port. If Landbridge was to default, it would lose its money. Any attempt by Landbridge to use the port as security to borrow money from a Chinese bank would trigger renegotiation of the lease.

The territory government retains a 20% stake in the port operator and has a say in key appointments such as the chief executive and chief financial officer. But it will not share any profit that Landbridge may eventually make.

That potential is a long way off. Landbridge Australia reported a loss of A$31 million for the 2017 financial year, with its total borrowings rising to A$463 million. If the deal falls over, the government will need to seek new equity partners. But its immediate commercial risks are relatively contained.

Other risks

Yet risk exposure may take other forms. China’s strategy is very long-term. Darwin is now on the front line in managing tensions between Australia’s most important strategic ally and partner and its major trading partner. Balancing between powerful friends with competing interests may not prove easy.

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There are indications of some recognition of this at the federal level. Australia’s foreign investment review processes have been tightened. A Critical Infrastructure Centre has been created to give extra national security advice. There has been some tweaking of rules about political parties accepting foreign donations.

But others may have learnt valuable lessons too.

Weaknesses in Australian governments at all levels have been revealed. They have been reactive, readily accepting the lure of pearls cast on our shores without considering longer-term currents. Foreign and strategic policy has effectively been left to the local level. While the federal government now seeks to shore up its interests in the Pacific with cash for infrastructure, similar commitments to investing in local infrastructure are essential.

Clumsiness and indecision do not serve Australian interests well.

John Garrick, Senior Lecturer, Business Law, Charles Darwin University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Soft power goes hard: China’s economic interest in the Pacific comes with strings attached

Red star rising: China has clear strategic designs on the Pacific Islands region.
Shutterstock

John Garrick, Charles Darwin University

China’s economic expansion into the Pacific Islands region raises critical questions for both the islands and Australia. What happens if infrastructure loans by Chinese banks and authorised state enterprises to vulnerable Pacific Island nations cannot be repaid? What consequences of default can be anticipated? Are there military dimensions?

The Pentagon has warned of the “potential military advantages” flowing from Chinese investments in other countries. China rejects this assertion. But if it does ever want access to foreign ports to support naval deployments in distant waters, it is laying the ground work to get it.

Belt and Road moves on the Pacific Islands

China’s grand plan to more closely link countries across Eurasia and the Indian Ocean through trade deals and infrastructure projects is known as the Silk Road Economic Belt and 21st Century Maritime Silk Road (“Belt and Road”). The plan includes Pacific pathways.

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The Belt and Road Initiative: China’s vision for globalisation, Beijing-style

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Along with Australia and New Zealand, seven Pacific Islands nations officially recognise the People’s Republic of China (PRC). Another six recognise the Republic of China (Taiwan). China’s strategy is both to counter Taiwan’s influence and further its own interests. It wants Pacific nations to support it in international forums. Vanuatu, for example, was the first country to support China’s claims to island territory in the South China Sea disputed with the Philippines.

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The number of Chinese companies operating in the Pacific region has greatly increased since Xi Jinping came to power in 2012. Trade between China and Pacific Island nations has ballooned to more than A$10 billion.

While its influence is still not as great as that of the US or even Australia, China’s growing investments cover mines, hydro-electricity projects, fishing, timber, real estate and services. Over the past decade it has also lavished the region with $US1.8 billion ($A2.4 billion) in foreign aid, including $US175,000 worth of quad bikes for Cook Island parliamentarians.

The soft power of money

China argues Chinese investment is “tactful” – that it helps developing nations build needed infrastructure with “no-strings-attached”. It contrasts this to Western aid models that require governance measures and other performance indicators to be in place in relation to aid funding.

But the credit Chinese state banks are extending to impoverished developing nations also looks a lot like a form of “debt colonialism”. The fear is that China is using the loans as leverage to expand its military footprint.

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Why China’s ‘debt-book diplomacy’ in the Pacific shouldn’t ring alarm bells just yet

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The Chinese loans typically offer a period of grace before an interest rate of 2-3% over 15-20 years is imposed. In Tonga, for example, China deferred loan repayments for a period after the International Monetary Fund warned it was at risk of debt distress. Repayments started again in 2018, reportedly at a higher rate than before.

Sri Lankan lessons

If Tonga and other Pacific Island nations default, China can enforce contractual conditions as a pretext to advancing wider strategic aims.

This is precisely what happened in Sri Lanka.

The Sri Lankan government had high hopes for the Hambantota Port Development Project, built by China Harbour Engineering Company, one of Beijing’s largest state-owned enterprises, and mostly funded by the state-owned Export–Import Bank of China. When the port failed to generate anticipated revenues, the government ended up owing China at least $US3 billion with no means to pay.

The Chinese then demanded a Chinese company take a dominant equity share in the port. The Sri Lankan government was also forced of hand over 15,000 acres of land around the port for 99 years.

Now China owns an Indian Ocean port strategically placed on one of the busiest shipping routes in the world.

Pacific interests

China has clear military interests in the Pacific. In 2014 Xi Jinping personally visited Fiji to sign memorandums of understanding including for greater military cooperation.

Australian intelligence sources allege China has been secretly negotiating to build a military base in Vanuatu. Both nations deny this. Such a base would give China a foothold for operations to coerce Australia and outflank the US and its base on Guam.

China’s “soft power” is being better resourced to influence foreign nations.
Its moves in the Pacific means the geopolitics of the region are hardening up.

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Read more:
Fears about China’s influence are a rerun of attitudes to Japan 80 years ago

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Globally, China’s rise has profound implications for international law and trade.

China naturally prefers bilateral relationships to leverage its power and advance its interests. It has steered away from multilateral dispute resolution, especially since the South China Sea arbitration, which ruled unanimously in favour of the Philippines. It has simply ignored the verdict and gone ahead turning the disputed rocky shoals into military outposts.

If China can ignore the legitimate claims of the Philippines, it can ignore the rights of the smaller and more fragile Pacific Island nations. Its actions flag its challenge to the international order Australia has long championed – one based on rule of law and political and economic liberalism.

Its influence is unlikely to promote democratic principles. Those holding those principles dear need to help the Pacific Island nations resist the lure of soft-power “incentives” promised with no strings attached.

There are definitely strings attached.

John Garrick, Senior Lecturer, Business Law, Charles Darwin University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Vital Signs: Australia’s stubborn growth problems are moving at a geologic pace

Unfortunately for the RBA, the health of the economy is not measured on the Geologic Time Scale.
Alfonso Silóniz/Flickr, CC BY-NC-ND

Richard Holden, UNSW

Vital Signs is a regular economic wrap from UNSW economics professor and Harvard PhD Richard Holden (@profholden). Vital Signs aims to contextualise weekly economic events and cut through the noise of the data affecting global economies.

This week: Interest rates remain on hold as the RBA talks up employment growth, green shoots remain in manufacturing, and China strikes back in the Trump-led trade war.

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On Tuesday, the RBA left official interest rates unchanged at 1.50% for the 18th consecutive meeting, tying their all-time record. They will break that record next month when they do the same thing.

And the official statement by governor Philip Lowe sounded like it came from a guy who had gone from crossing his fingers to crossing his toes as well. For example:

“The Australian economy grew by 2.4 per cent over 2017. The Bank’s central forecast remains for faster growth in 2018.”

Um, why? The same macro model that got 2017 wrong is now going to get 2018 right?

Or this one:

“The unemployment rate has declined over the past year, but has been steady at around 5½ per cent over the past six months. The various forward-looking indicators continue to point to solid growth in employment in the period ahead, with a further gradual reduction in the unemployment rate expected.”

But a few months ago, those same forward-looking indicators were saying the plateau in the unemployment rate wouldn’t happen.

And finally (but only because I have space constraints):

“Notwithstanding the improving labour market, wages growth remains low. This is likely to continue for a while yet, although the stronger economy should see some lift in wages growth over time.”

If “over time” is read analogous to “life in the Mesazoic Era evolved over time” then I suppose that may be right.

Unfortunately for the RBA, the health of the economy is not measured on the Geologic Time Scale. Stubbornly low inflation, persistently hopeless wage growth, and with the Australian population growing at 1.6% p.a., that 2.4% GDP growth number looks pretty weak. The real question is whether the RBA is not cutting rates because it thinks monetary policy is ineffective at this level, or because it’s scared of fuelling (further fuelling?) a (the?) housing price bubble.

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Read more:
What economics has to say about housing bubbles

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ABS data released Wednesday showed a drop in building approvals in February. Total dwelling approvals were down 6.2%, driven by a 16.4% drop in apartments, compared to a 1.9% rise in houses. For the 12 months to February 2018, that puts the total down 3.1%, again driven by a large (14.8%) drop in apartments and a rise (6.1%) in houses.

This is all evidence that demand – often from offshore – has dried up in one important sector of the market: apartments. It is still too early to know what the fallout will be, but this is exactly the kind of pattern one sees in property markets when the music has stopped.

The Australian Industry Group’s Performance of Manufacturing Index, released this week, hit a record high of 63.1 index points for March. Perhaps more importantly, the survey indicated that capacity utilisation was at a record high of 81.2%. This matters because it suggests stronger employment and wage growth in the sector.

On the other hand, manufacturing is about 6.5% of GDP, so even strong growth in the sector has a relatively modest overall effect. But, as they say in baseball, you can’t boo a home run.

US jobs figures continued to impress, with payroll processor ADP releasing figures Thursday Australian time that the economy added 241,000 jobs in March. The official figures from the BEA come out Friday US time, with market expectations at an addition of 185,000. So if the official figures line up with ADP, this will be further evidence of strong employment growth.

Trump trade war update

This week, China struck back, again. The Trump administration recently instituted roughly US$50 billion worth of tariffs on steel, cars, automotive and aircraft parts, consumer products like televisions, and other goods. Almost immediately, China responded with tariffs of a similar value on 106 types of American goods.

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Read more:
America’s allies will bear the brunt of Trump’s trade protectionism

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Those 106 types of goods include soybeans and others produced in the Trump heartland. This was a cleverly designed, targeted measure, designed to hurt Trump politically.

His response:

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That reveals his mercantilist view of trade: that it’s a zero-sum game rather than something that increases the size of the economic pie and makes both countries better off. But hey, maybe he has a big reading backlog and isn’t up to 1817, when David Ricardo pointed this out with his theory of “comparative advantage”.

Let’s hope it does, and President Trump gets the message that he needs to knock this off. All he is doing is making America poorer. And the game theory of it is worse. Tariffs beget tariffs.

Richard Holden, Professor of Economics and PLuS Alliance Fellow, UNSW

This article was originally published on The Conversation. Read the original article.

China’s economic power is actually a lot smaller than you think

Peter Robertson, University of Western Australia

China’s economic presence on world markets is actually much smaller than that of the United States of America and smaller than our key three asia-pacific allies combined.

In recent years, reports by financial institutions like the World Bank have claimed China is the world’s largest economy. China’s annual gross domestic product (GDP), when converted to United States dollars using purchasing power parity exchange rates is estimated to be worth around US$19 trillion, surpassing the USA’s GDP of US$17 trillion.

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Read More: As China flexes its muscles in Antarctica, science is the best diplomatic tool on the frozen continent

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China’s size is a good indicator of potential economic opportunities for Australia. But China’s rise is also creating a growing discomfort in how China will use its economic power. In both Washington and Canberra questions are being asked about how to our balance economic interests with these growing political and security concerns.

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As a large country China may insist on a greater acceptance of its own ideals and priorities as a condition of economic engagement. As a dictatorship, however, its ambitions are unclear and may not align well with Australia and other democratic countries in the region.

Likewise China’s assertiveness in the South China Sea has rekindled interest in security cooperation between the region’s largest democracies, Japan, India and Australia, as well as the United States through the Quadrilateral Security Dialogue.

The concerns raised are real, but are in some ways exaggerated. Specifically, the figure of US$19 trillion is an estimate based on a purchasing power parity exchange rate, which overstates China’s impact on world markets.

This is because the purchasing power parity exchange rate tells us how much money you need in China to be as well off as you are in the US. It is a measure of how big China’s GDP would be if costs of living were the same as the US.

This can be useful, but it is not an indicator of China’s footprint in the world economy.

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Read more: Australia is hedging its bets on China with the latest Foreign Policy White Paper

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A reasonable measure of a country’s economic footprint on the world economy is how much it could potentially change demand or supply on world markets.

When countries export they have to accept payment based on market exchange rates. Likewise when countries import they must pay in foreign currency based on market exchange rates. This means that to compare China’s market size with the US, we need to convert China’s GDP, measured through China’s currency renminbi, to US dollars, using market exchange rates.

China’s GDP measured at market exchange rates, however, is only US$9 trillion – almost half that of the US.

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This means that the impact China’s economy can potentially have on the world economy is really only about half as much as the US.

The difference in values arises for the same reason that tourists find that their money often goes much further in developing countries. That is if you convert your US dollars to renminbi, you will find that you can purchase a lot more in China than the US, especially in non traded goods and services such as haircuts or street food.

The purchasing power parity exchange rate is the rate that tells you how much you need in China to be just as well off – for example to buy the same basket of goods. It’s very useful rate for tourists and is great way to compare standards of living across countries.

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Read More: China’s growing footprint on the globe threatens to trample the natural world

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But it’s not a measure of how much you can actually buy. In order to measure the potential influence of China’s economy, it is buying and selling power that matters.

The same line of reasoning also effects how we should think about the asia-pacific partnership of regional democracies. The combined GDP of India, Japan and Australia, measured at purchasing power parity rates is smaller than China.

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But at market exchange rates their combined market size exceeds that of China. This is because just as purchasing power parity exchange rates make China seem too big, they make Japan seem small relative to its real buying and selling power on world markets.

The collective GDP of Japan, Australia, India and the United States represents a market that is around three times larger than China.

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These differences are quite significant and they are important because they affect the way we think about the value of economic opportunities and our security alliances. When interpreted appropriately China is a large country. But it still has a long way to go before it can match the sheer economic weight of the US.

So while China is very important, the market size of regional democracies should not be underestimated.

Peter Robertson, Professor, University of Western Australia

This article was originally published on The Conversation. Read the original article.

Government budget update saved by higher than expected economic figures

Saul Eslake, University of Tasmania

The 2017-18 Mid-Year Economic and Fiscal Outlook (MYEFO) is another reminder – if one is needed – that the relationship between the budget and the economy runs in both directions. While we mostly ask the question, “how will the budget affect the economy?”, this update shows the economy can also have (and has often had) a significant impact on the the budget.

The highlights of this year’s MYEFO, as far as the government is concerned, are the A$9.3 billion improvement in the underlying cash balance over the four years to 2020-21 (compared with what had been forecast in the May budget), and the consequential A$11 billion reduction in the forecast peak in net debt (from A$366 billion to A$355 billion) in that year.

These improvements are the result of revisions to economic assumptions and other so-called “parameter variations” since the budget, which in total have improved the four-year bottom line by more than A$11 billion. The biggest of these came from reductions in payments to people with disabilities, students, single parents and age pensioners (totalling A$4.6 billion over four years) due to lower-than-expected recipient numbers.

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Read more: Budget update shaves growth and wage forecasts but is brighter about the deficit

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Personal income tax cuts seem possible

There is no additional detail in MYEFO regarding the government’s foreshadowed personal income tax cuts ahead of the next election. But if the forecast surplus for 2020-21 of A$10.2 billion is credible, then there’s arguably some scope for the government to fund personal income tax cuts beginning in that year.

Although the cost of more significant tax cuts would escalate substantially over the medium term, there is actually more scope for these cuts than generally realised (provided the government succeeds in keeping growth in spending under control).

That’s because the projected moderate surpluses, averaging about 0.5% of GDP out to 2027-28, incorporate an arbitrary assumption that taxation revenue will be capped at 23.9% of GDP. If that assumption wasn’t made, the projected surpluses would rise to 1.6% of GDP by 2027-28.

In dollar terms that would imply a surplus of around A$55 billion, compared with one of around A$15 billion if the surplus were only 0.5% of GDP. Over the period 2021-22 to 2027-28, relaxing the assumption that tax revenues are capped at 23.9% of GDP results in almost A$90 billion of additional budget surpluses. This is over and above what is projected with that “tax cap” in place.

Presumably, some of those “additional surpluses” are absorbed, in the government’s internal figuring, by the promised phased reduction in the company tax rate for businesses turning over more than A$50 million per annum by 2025-26 – which according to the last publicly available estimate would reduce revenues by some A$65 billion over ten years.

However, that would still leave a considerable amount “left over” to pay for personal income tax cuts, and allow the government to continue to project surpluses of around 0.5% of GDP out to the second half of the next decade.

That’s assuming, of course, that we are able to clock up 36 years of uninterrupted economic growth, and that all the other projections come to pass, including for a return to more “normal” rates of wages growth.

Economic indicators in MYEFO

Treasury has revised downwards its forecast for economic growth in the current financial year, from 2.75% to 2.5%. A large part of this revision comes from stronger growth in public spending, which is now forecast to rise by 4% in real terms in 2017-18, up from 2.5% at the time of the May budget.

This reflects faster growth in both government spending (on the NDIS) and investment (NBN and state government infrastructure investment). The forecast for business investment has also been upgraded, from flat at budget time to growth of 2%, the result of both stronger growth in non-mining business investment and a smaller decline in mining investment.

This is largely the result of a downward revision to the forecast for growth in household consumption spending which has been lowered from 2.75% to 2.25%: and this carries over into a 0.25 percentage point reduction in the forecast for 2018-19, to 2.75%. Even these require a further decline in the household saving rate.

The forecast for dwelling investment spending has turned around from 1.5% growth to a decline of 1.5%, with the “softening in dwelling investment occuring slightly earlier than expected”.

Longer term, the government is still anticipating that economic growth will average 3% per annum from 2018-19 through 2023-24, by which time all the “spare capacity” in the labour market will have been absorbed. That is, the unemployment rate will be down to 5% and underemployment (workers not being able to get enough hours at work) returned to more normal levels.

The longer-term projections also assume that wages growth accelerates significantly from 2019-20. This represents the greatest risk to the goverment’s promise of a return to surplus by 2020-21.

Saul Eslake, Vice-Chancellor’s Fellow, University of Tasmania

This article was originally published on The Conversation. Read the original article.