It's No Wonder Australia Has an Underground Economy

Suddenly, all’s well again. In fact, overnight it was the best day of 2014 so far for US stocks. But it was yesterday’s trade balance news in Australia that packed a punch in our market.

First, November’s data was revised from a deficit into a surplus of $83 million. And then the expected $200 million deficit for December came in at a $468 million surplus! Together, these were the first trade surpluses in two years.

Better still, both exports and imports surged. Exports rose 15.1%, with agricultural products leading the way. And imports rose 6.4%. Good times, right?

Maybe. China took 38% of our exports and is a leading contender for future growth as well. In other words, we’re relying on the Chinese to keep our trade balance in the right kind of imbalance.

But China is steadily emerging as the latest trouble spot in the world economy. In fact, that’s sort of been the narrative lately. One country after another hits economic trouble and no country seems to be able to escape it.

But China is the elephant in the room, especially for Australia. And there’s trouble brewing in its credit system. A new kind of trouble.

Until recently, China’s credit system relied largely on organic growth. The shadow banking system channelled vast savings into property. But foreign investors are increasingly supplying the funds into China. That’s a good thing, except foreign investors are notoriously prone to doing a runner when it’s most inconvenient. And in credit markets, doing a runner creates a significant problem. Borrowers need to be able to roll over debt – borrow to repay earlier borrowings.

Rolling over debt sounds a bit dodgy. And it can be. But in this case, it needn’t be. Companies want to maintain leverage levels to enhance profit. Rolling over debt is a part of that. The problem arises when the credit market dries up and interest rates surge. Then borrowing the new loans to pay off the old ones turns the business unprofitable, especially property based businesses which use a lot of leverage.

Apart from using foreign investors, the Chinese are making another rookie mistake. They’re borrowing in foreign currencies, especially US dollars. The amount borrowed is likely to have surpassed $1 trillion recently going by Bank of International Settlements 2013 figures. While times are good, that’s fine. But if China’s currency falls, the borrowed debt becomes expensive. Just about every emerging economy makes this mistake, and it’s always exposed during a financial crisis. But most emerging markets don’t have the potential to launch a global economic crisis like China does.

A problem in Australia’s biggest export market would mean trouble for our economy. But there’s still plenty of trouble without it. For a very long time, politics is the closest most Australians have come to economic matters. And it looks like a new industrial relations spat is brewing. Quite frankly, we can’t stand reading about it. Everyone simply says exactly the same thing as they have for as long as industrial relations have existed.

Business wants a ‘new national compact’ where we all sit in a circle, hold hands and sing hallelujah. Unions want to be able to picket, pocket and protest. Government officials want to inspect and boss people around. Politicians want the credit for all this nincompoopery.

We did read one completely bizarre comment from Tony Boyd in the Australian Financial Review: ‘Business appears unwilling to get its hands dirty. It does not have skin in the game when it comes to big debates about reform of industrial relations and taxation policy.’ What? No skin in the game?

Clearly Boyd hasn’t heard of Aesop’s Fable on the Sun and the Wind. The two have a bet on who can make a man take his jacket off first. The Wind goes first and blows as hard as it can at the jacket. But the harder it blows, the tighter the man does his jacket up. Then the Sun comes out, shines on the man, and he takes off his jacket.

Clearly business’s silence is a ploy. It’s hoping politicians manage to spin industrial relations reforms in a way that benefits workers. The more enthusiastic business is, the more suspicious workers will be.

All this politicking around is a complete circus and farce. One that exists because government has the power to interfere. And so business, unions and consumers start acting like politicians to try and move policy. That’s why the lowest common denominator gets the policy they want. You have to stoop to a politician’s level. If employees and employers were free to make their own agreements, there would be far more jobs and far better conditions, with far more profit and wages. That’s true by definition.

When two people enter into any agreement, employment or other, they only proceed if the agreement is mutually beneficial. They both have to be better off, otherwise they would not enter into the agreement.

Add in a government bureaucrat with regulations and conditions, and all you get is transaction costs. Taxes to pay for the bureaucrat, price restrictions on the agreement like minimum wages, safety restrictions based on regulations instead of efficacy, compliance costs, and countless other factors which simply drive the two people making the agreement apart. It adds conditions that they may not have required given the freedom to avoid them. In the end, less agreements are possible, and less mutually beneficial agreements are made.

For example, an employee might want to work for less than the minimum wage in exchange for training. With minimum wage laws, the employee will not be trained or employed. Both employee and employer miss out. Unless they flaunt the law, as we did in our first real job.

Of course if the government comes up with a program to facilitate this kind of training with lower pay, the cost on the employer through compliance and taxes makes it a burden that restricts how often it can happen. Either way, everyone except the politician and bureaucrat is worse off.

You can’t mention industrial relations without talking about unions. They could conceivably be a crucial part of the economy. Representing workers as a group can balance corporate power without being unfair. But that’s not what unions do anymore, if they ever did. They made two huge mistakes. First, they engaged in illegal activity like roughing up workers who don’t join the union.

Worse still, unions began entering politics and creating laws. Instead of counteracting the power of big business, they became the referee. Now people don’t need unions to protect themselves. The unions have turned themselves into a divisive and irrelevant force. And they wonder why membership is declining.

The reason politics is so dangerous is power. While a union is a force for good, doing the right thing and balancing corporate power, people join it. If the union goes off the rails, people leave and go their own way with their employer. That way everyone is accountable.

If the unionists get a job in Canberra, their manipulations are permanent and unavoidable. You can’t opt out and go your own way. Or can you?

Surprise, surprise, Australia’s black market is on the move. The underground economy is booming according to anecdotal evidence from James Adonis in The Age. The proud Greek is trying to prevent Australia from falling into the same sort of chaos as his other home. His solution is to ask his cleaner for a receipt each fortnight.

We’re quite sceptical about Adonis being Greek, to be honest. He claims to be surprised you can earn more being unemployed, collecting benefits and working in the underground economy than you can working in the taxed economy. If he really is Greek he’d know this intuitively. The Spanish know it genetically. They have a proud tradition of working in the black market regardless of financial crises.

Adonis probably has it backwards anyway. He reckons the black market is terrible – look at what it’s done to Greece. But nobody knows what it’s done to Greece. The black market could be what’s keeping people alive and eating. It could be the sole source of hope and prosperity. It could be the average Greek’s way of throwing off the parasitic state and its absurd industrial relations policies.

Here’s a good example of what we mean closer to home, from the same article:

The Howard government claimed the introduction of an ABN would curb the underground economy because it heightened the chances of such behaviour being detected. As the Treasurer Peter Costello professed at the time: "This tax cracks down on the black economy, and that’s the whole idea of it."

But that was not to be the case. An analysis a few years later by the Taxpayers’ Research Foundation concluded the underground economy had actually increased by 1 per cent.

Of course, the measure of whether GST (which was introduced at the same time as ABN) reduced underground economic activity isn’t whether it increased or decreased after GST was introduced. After all, the underground economy would increase or decrease all the time regardless of economic policy. Not to mention the millions of other laws passed that affect it. Instead, it’s all about whether the introduction of GST increased or decreased underground activity more than other factors would have. In other words, if the underground economy would have doubled in size without GST, it would be a success.

The counterfactual – what would’ve happened without a policy – is the bane of economics. That’s why journalists ignore it. And it’s why the public has no clue about the effect policies have. Neither do economists, to be honest. But they spend a lot of time looking like they’re trying to figure it out.

To be clear, we haven’t the foggiest idea whether GST increased or decreased the underground economy either. But we do know that nobody else knows either. The World Bank estimates Aussie underground activity at 14% of GDP while the Australian Bureau of Statistics believes it’s more like 2%.

If we had to guess, adding paperwork and taxes is going to make the underground economy surge.


Nick Hubble+
for Markets and Money

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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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