Working Papers

2009 04

Akerlof and Shiller’s Economic Authoritarianism

My review of George Akerlof and Robert Shiller’s Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism (Princeton: Princeton University Press, 2009), below the fold.

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posted on 30 April 2009 by skirchner in Economics, Financial Markets

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Why the RAAF is Years Ahead of the USAF

The Royal Australian Air Force is a good seven years ahead of the US when it comes to scaring office workers with low altitude photo shoots.

posted on 28 April 2009 by skirchner in Foreign Affairs & Defence

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Robert Prechter Discovers Rational Expectations

Robert Prechter’s latest Global Market Perspective argues that:

movements in the cash target rate set by Australia’s central bank, the Reserve Bank of Australia (RBA), appear to follow those in 3-month Australian Treasury Bills. After decisive moves up in T-bills from 2006 to early 2008, for example, the RBA faithfully raised its target. T-bills have since led the RBA during the financial crisis of the past year. In fact, the record indicates that the RBA almost always follows T-bills over time.


The proper conclusion to draw… is that their interest-rate decisions are not proactive, but reactive, and that they continually follow in the footsteps of the market for lack of any other useful guide…. The myth of central bank potency is so pervasive that conventional analysts can’t even imagine a better explanation for price trends: that the market is the dog wagging its central bank tail, not the other way around.

The fact that market-determined interest rates lead official interest rates does indeed have a better explanation: the market successfully anticipates central bank policy actions.  This does not render central bank policy actions ineffective, as Prechter would have us believe.  Indeed, it makes monetary policy more potent, because central banks can influence monetary conditions through open mouth rather than open market operations.  But it does point to the fact that both market and official interest rates are largely endogenous to economic activity.  Both the market and central bank look at the same data in much the same way, drawing similar conclusions.  The main difference is that the markets make these judgments every day, while the central bank acts on them more slowly.

posted on 26 April 2009 by skirchner in Economics, Financial Markets

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A New Era in FDI Protectionism?

The conditional approval of Minmetals’ acquisition of OZ Minerals’ assets under the Foreign Acquisitions and Takeovers Act marks what may well be a new era in FDI protectionism.  Indeed, the Treasurer’s press release states explicitly that the conditions and undertakings required of Minmetals ‘are designed to protect around 2000 Australian jobs.’  Some of these conditions, such as the requirement to ‘comply with Australian industrial relations law and honour employee entitlements’ are legal obligations of any company operating in Australia, regardless of ownership, and are therefore completely redundant.  The reporting requirements imposed on the company are also already required under the Corporations Act.  This is a perfect illustration of how scrutiny of FDI under the FATA adds nothing to the regulation of business investment in Australia. The FATA’s only real purpose is to serve as a vehicle for political intervention in the market for foreign ownership and control of Australian equity capital.

In this case, political intervention has resulted in some extraordinarily prescriptive conditions in relation to both corporate governance and operational matters.  For example, Minmetals is required to: 

1. continue to operate the Century, Rosebery and Golden Grove mines at current or increased production and employment levels;
2. pursue the growth of the following projects:
1. the Century mine in Queensland, by the continuation of exploration activities for ore and/or the conversion or later sale of the plant so that it can produce a phosphate concentrate; and
2. the Rosebery mine in Tasmania, which with further exploration and development work, could continue to operate well beyond current mine life or at levels beyond current production rates; and
3. reopen Avebury (nickel) in Tasmania and develop Dugald River (zinc) in Queensland;

subject in each case to project feasibility and economic fundamentals permitting.

The weasel clause is, of course, ‘economic fundamentals permitting.’  Since there is no legal basis for determining ‘economic fundamentals’, these conditions are meaningless, except that the Treasurer has powers under the FATA to order divestment by foreign persons.  The conditions could conceivably be used to rationalise a future divestment order, but there is no need to demonstrate a breach of these undertakings for the Treasurer to exercise his powers under the Act.

The current government is sending increasingly strong signals to prospective foreign investors that they will have to conduct their business operations in Australia in accordance with politically-determined requirements and objectives rather than according to the rule of law.

Sadly, the government’s increasingly prescriptive regulation of FDI is no different from the protectionist views of Liberal backbencher and former Treasurer, Peter Costello.  With a seemingly bipartisan consensus in favour of FDI protectionism, foreign investors could be forgiven for looking elsewhere.  Indeed, China’s National Development and Reform Commission withheld approval for Hunan Valin Steel’s bid for 17% of Fortescue Metals on the grounds that Canberra’s conditions were too onerous and set a bad precedent.  Australia’s regulation of FDI offends even Chinese central planners.

posted on 24 April 2009 by skirchner in Economics, Foreign Investment

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P J O’Rourke’s John Bonython Lecture in Sydney

For those who couldn’t be there, Lateline covers P J O’Rourke’s John Bonython Lecture to the Centre for Independent Studies.  Full video on the CIS website in due course.

posted on 22 April 2009 by skirchner in CIS

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‘Whatever it Takes’: A Wicked Idea

Jamie Whyte, on the long-term damage wrought by fiscal stimulus measures:

So, despite near universal agreement that governments must do “whatever it takes” to avoid a severe recession, this is an absurd idea. Perhaps even a wicked idea. The important question about the kind of actions most governments are now taking – “bailing out” failed companies and massively increasing government spending – is what their long-term effects will be.

Those few commentators who worry about long-term effects tend to focus on the debt burden created by stimulus packages. But this is a trivial and short(ish)-term issue. If there is no structural damage to the economy, servicing these debts will be reasonably easy. A stimulus package would simply transfer wealth from the nation’s future citizens to its present citizens. And that does not constitute a net loss to the population.

Indeed, if the stimulators are right about the effects of their proposals on long-term GDP, even future citizens who bear the debt burden might be grateful for the transfer. Better to be rich with big but manageable debts than to be poor. These future citizens would be like people who had borrowed to get a medical degree.

The serious question about stimulus packages concerns not the short-term accountancy, not the details of jobs today and debt tomorrow, but the structural effects on economies. Are stimulus packages really like borrowing to get a medical degree or are they more like taking brain-damaging drugs to eliminate an acute headache?

Chris Berg looks for method in the madness of fiscal stimulus efforts in Australia and decides the government is just making it up:

Sure, it seems fun watching the Government conjure up jobs and prosperity out of nowhere, but in retrospect, after none of those jobs appear, the economy keeps going down the toilet, and bureaucrats have eventually admitted they made it all up — it’s actually quite depressing.

posted on 17 April 2009 by skirchner in Economics, Fiscal Policy

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Explaining Capital Xenophobia: Cranky Old Conservatives?

The latest Newspoll asks whether foreign companies should be allowed to acquire shareholdings in Australian mining companies.  A separate question asks whether Chinalco should be allowed to increase its stake in Rio.  52% of respondents are opposed to the former and 59% to the latter.  Opposition is stronger among Coalition voters than Labor voters, which may reflect National rather than Liberal Party voters.  Opposition also increases with age.  While it would be tempting to conclude that capital xenophobia is mainly attributable to cranky old conservatives, there is still more opposition than support even in the 18-34 age group.

Taken literally, the question on foreign shareholdings in mining companies implies that Australians are opposed not just to foreign direct investment, but to foreign portfolio investment as well (a 10% equity stake is enough to qualify as FDI according to the ABS; the threshold for FIRB scrutiny is generally 15%).  In any event, this and other opinion poll data (see Andrew Norton’s round-up) render Australia’s FDI controls readily explicable in political terms. 

Opposition Treasury spokesman Joe Hockey has even sought to raise concerns about foreign (ie, Chinese) portfolio investment in Australian debt markets, arguing that this might give the Chinese leverage over Canberra.  Like US debt markets, Australian markets are deep and liquid enough that the Chinese are unlikely ever to be effective price-makers.  Chinese threats to sell-off Australian dollar denominated debt would just provide a buying opportunity for other investors, to the detriment of their own portfolio.  But excluding all foreigners from participating in Australian debt markets would of course lead to a massive increase in domestic interest rates, something voters wouldn’t be too thankful for.

The irony is that at the same time the government is setting up Rudd bank to offset the implications of potential foreign capital flight for the commercial property sector, and politicians complain about the failure of banks to pass on reductions in official interest rates, neither the government or opposition are putting out the welcome mat to foreign capital.

posted on 08 April 2009 by skirchner in Economics, Financial Markets, Foreign Investment

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Should We Use Monetary Policy to Regulate Human Nature?

Writing in the letters page of today’s AFR (no link), Des Moore says:

Whether or not a targeting of asset prices warrants more attention, any review of policy surely needs to address the difficult issue of changes over time in human nature…

There is a long history of swings in attitudes from optimism to pessimism, often “inspired” by governments, that result in changes in risk behaviour: our most recent swing of optimism was reflected in the boom in investment in commodity production. 

If monetary policy does not pay sufficient regard to such swings, it is very likely that we will end up with a “bust” - and high unemployment. That is what happened in the 1980s and what is happening now…

The idea that human nature is variable at business cycle frequencies is highly questionable, as is the assumption that the monetary authorities are somehow immune to these ‘swings of attitude’.  Des falls into the classic trap identified by public choice theorists of assuming that human nature changes when we relocate people from the private to the public sector. 

In arguing that the recent boom in commodity investment was a ‘reflection’ of ‘our most recent swing in optimism’, Des Moore identifies himself with behavioralists like Robert Shiller, who maintain that sentiment drives economic activity, rather than the other way around.  But as I argue in Bubble Poppers, the more asset prices are thought to be disconnected from the real economy, the weaker the case for using monetary policy to regulate asset prices via the real economy.

posted on 06 April 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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Canberra is the Problem, Not Beijing

I have a column in today’s Business Spectator arguing that it is Australia’s regulatory regime for FDI that is responsible for perceptions of inappropriate Chinese influence over the federal government:

China may well have the world’s most restrictive FDI regime, but Australia has the fifth most restrictive regime, based on one OECD measure. Australia’s highly politicised FDI controls more closely resemble those found in China and Russia than comparable countries like the United Kingdom and the United States. Is it any wonder that Chinese politicians finds themselves on familiar ground when lobbying Australian politicians over potential acquisitions?

If Australians are really concerned about the potential for Chinese influence over foreign investment policy, they should support making Australia’s regulatory regime for FDI less like China’s and more like the UK’s.

The priority for any reform should be removing ministerial discretion from the FDI approval process. This is the main source of the politicisation of foreign investment in Australia and the nexus for potential influence-peddling by sectional interests, including by foreign firms and governments…

The real scandal is not the potential for Chinese influence over Australian politicians. It is the Whitlam-era, Chinese-style foreign investment regulatory regime we have inflicted on ourselves.

posted on 01 April 2009 by skirchner in Economics, Foreign Investment

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