AI and the failure of economics

Introduction

The media debate over tariffs and productivity is not based upon sound economic theory. The current debate in western economies should be about generational change and rejection of post 1971 globalised market economics. Moreover, the advent of AI and its potential impact upon the structure of the economy and service sector employment appears unable to generate comment from either major political party or plethora of economic "experts" and commentators gracing our nightly television screens. This short essay attempts to raise some discussion of the potential impact of AI on the economic system and employment.

The economic model that eventually emerged post 1971 was a monetarist/neoclassical synthesis based upon the heroic assumption of rational expectations. Across western economies, monetarist central banks assumed management of monetary policy. As governments abandoned the post War economics of J M Keynes, direct management of the economy was abandoned in favour of market theories. This mix of philosophies from the late nineteenth early twentieth century has no answers to what is happening in today's real world let alone offering a sound strategy for what is quietly infiltrating our economic system in the guise of economic efficiency.

In the field of international economics, an economy is considered efficient when both internal and external sectors are in balance. Internal balance is achieved when an economy is operating at full employment output under stable prices. External balance is achieved when there are no unwanted movements in the balance of payments. Critical in external balance is balance on current account. The balance on current account is the net position of the current account combining the balance of trade and the net income deficit. The net income deficit is the difference between the income flow from foreign investment and the net income flow of income earned by Australian investment earned overseas. Hopefully this becomes clearer as the discussion progressesInternal balance

Chat 1

            Compiled from RBA Statistical tables Feb. 2026

"Internal balance is achieved when an economy is operating at full employment output under stable prices".

Full employment in Australia is considered the RBA's NAIRU otherwise known as the natural rate of unemployment. NAIRU, which stands for the Natural Accelerating Inflation Rate of Unemployment, is considered to be between 4% - 4.5% unemployment. When actual unemployment is at NAIRU, the RBA considers inflationary pressures are neutralised. Consequently, NAIRU becomes the determinant of domestic monetary policy and interest rate settings.

NAIRU is directly derived from the rational expectations Phillips Curve. The monetarist/ neoclassical synthesis that underwrites modern macroeconomics across the western world is based upon rational expectations. It first emerged in Britain in 1976 under British Labour. The concept came to Australia in 1993 when the RBA assumed independent setting of monetary policy.

Facing the increasing adoption of AI, the contemporary real issue becomes what happens to monetary policy settings. What level of unemployment becomes the new natural rate of unemployment or NAIRU. There is no serious discussion on the impact of AI on Australian employment. However, daily there is news of a major service industry shedding large numbers of employees. Given the nature of service industry employment, it is reasonable to expect unemployment will not be confined to low skilled workers. Many highly skilled industries such as law, accounting, banking, public service, and other advisory industries must be natural targets for AI.

Upon acceptance of AI, the big questions for government becomes economic policy.

What happens to NAIRU and monetary policy?

How is the inevitable rise in unemployment managed?

External balance

External balance requires balance across both external accounts ie the financial account and the Current account. The financial account manages the flow of investments into and out of Australia whilst the current account covers import and export flows affecting GDP and national income. The following equation explains the structure of an economy.

Y = C+ I + G + (X-M)

Y = GDP

C= Consumption

I = Investment

(X-M) = exports – imports

(X-M) comprises the trade balance, and the balance on current account. The difference between the trade balance and balance on current account is the Net Income Deficit. The NID is the difference between income earned by foreign investment in Australia and income earned by Australian investment overseas. Chart 2 demonstrates graphically external balance.

Chart 2

Compiled from RBA Statistical tables online

Mathematically, net income deficit becomes a negative contribution to (X-M) in the equation

Y = C + I + G+ [(X -M)-(Net income Deficit)]

The mathematics of external balance makes the political argument of productivity little more than an ideological slogan of questionable economics.

The net income deficit makes itself felt through the money supply. If the money supply is defined as

Ms= R + DCE

Ms = money supply

R = reserves

DCE = domestic credit creation

Whilst the net income deficit directly affects DCE, its impact upon the domestic economy and employment is its impact upon (X-M) and the money supply. In other words, the impact of a negative net income deficit can be understood from the GDP equation above.

Conclusions

As AI investment will be largely the province of large international corporations, external balance and the net income deficit must become major policy issues. These following questions need to be address by our politicians across all parties.

What impact will AI have on national sovereignty?

Which industries will be affected by AI?

How will rising unemployment be addressed?

How will income distribution be affected and managed?

What new industries will counter the employment impact of AI?

What type of training will the future workforce require?

What AI preparation is being structured by contemporary tertiary institutions?

Contemporary generations are working under the real outcome of the economic ideology of the Baby Boomers and Gen X. As contemporary generations continue to outnumber earlier generations, inequalities across society can only worsen. As AI becomes adopted by Australian industries, the impact upon modern generations must be addressed. The time to plan is now not sometime in the future.