Date created: 28 January 1998

Last modified:18 December 2002

Maintained by: John Quiggin

The real economic illiterates

18 September 1997

Intro:

The policy elite who were so quick to condemn the TCF tariff pause, are in fact the ones who are economically illiterate, argues John Quiggin.

Text:

The economic policy elite has been quick to condemn the Howard Government's capitulation to public pressure on tariff protection for the textile, clothing and footwear industries. Particular scorn has been poured on the belief that tariffs save jobs. "Economic illiteracy" has been among the kinder terms used to describe this belief.

The only problem is that it is the policy elite who are economically illiterate. Anyone who bothers to read a textbook on international economics will find the wellestablished proposition that protection of a labourintensive industry tends to raise the demand for labour at any given real wage. If, as in Australia, real wages do not adjust freely, employment will rise.

This was first pointed out by the Australian economist J.B. Brigden and his colleagues in the 1920s, and, more rigorously, by Paul Samuelson and Wolfgang Stolper in the 1930s. As the economics profession prefers mathematical proof to verbal reasoning, Brigden's argument is now known as the "StolperSamuelson theorem".

A number of the economic illiterati, along with some economists who should know better, have suggested that standard economic analysis can be ignored because it is "static". They claim that adoption of the policies they favour will lead to unspecified "dynamic" gains, which will dwarf any effects that might be predicted by mainstream economics. This kind of claim can be, and has been, made in support of any kind of policy. It represents the kind of wishful thinking that has done more than anything else to discredit the case for microeconomic reform.

The reason economists have not, in general, favoured tariff protection is not because it cannot create jobs, but because it is not a very costeffective way of doing so. Much of the benefit of tariff protection goes to the owners of capital in the protected industries, and is therefore wasted as far as the objective of employment growth is concerned.

Tariffs on labourintensive goods are less costeffective than production subsidies for the same goods, which, in turn, are less costeffective than general wage subsidies or, equivalently, reductions in payroll taxes.

More costeffective than any of these would be direct public action to expand employment in the most labourintensive of Australian industries, the community services sector. Increased funding of education, health, environmental services, police services and so on, funded by higher taxes, would greatly increase the quantity of labour demanded at any given level of real wages and aggregate demand.

Furthermore, because an increase in taxes would reduce import demand, an expenditure switch of this kind would address Australia's chronic current account problems, having the same effect as a favourable shift in the terms of trade.

Thus, even if trade protection can protect jobs, there are usually better policies available. This argument cannot be put forward with any credibility by members of the Howard Government, however. In its 18 months in office, the Government's unemployment "policy" has consisted of two trivial gimmicks: the modification of unfair dismissals legislation and the "work for the dole" program. The Government has cut the limited wage subsidy and job creation schemes it inherited from Labor's Working Nation program (already cut by Labor in the 1995 Budget). More significantly, it has cut Commonwealth public sector employment and further tightened the squeeze on the States imposed under Labor.

Finally, it has abandoned any pretence of an unemployment target, while directing the Reserve Bank to focus its attention solely on inflation. All of these measures have raised unemployment, and all were cheered on by the policy elite. The only policy response to unemployment which is considered acceptable by the policy elite is a massive cut in both real wages and social welfare benefits.

Even if this policy worked, which is by no means certain, it would entail a net increase in poverty, and social effects worse, in many respects, than those of high unemployment. Not surprisingly, most voters are not attracted to proposals of this kind, and the Howard Government has not pursued them with any vigour.

With luck, the TCF tariff pause might generate a net saving of a few thousand jobs, at a fairly high cost per job. At best, it would represent a marginal contribution to resolving our problems. Yet even this minimal outcome would represent a greater contribution to reducing unemployment than anything the Government has done since it took office.

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