Saturday, December 10, 2016

How to tell if recession looms

What would economic race-calling be without its little excitements? As you may possibly have heard, this week's news is that the economy has contracted - shrunk, gone backwards - by 0.5 per cent.

Oh, no! Another negative quarter will see the economy lapse into "technical" recession. Technically true, but quite unlikely - as almost all the money market economists had the honesty to admit.

If you're more practical than technical, and you live in Sydney or Melbourne, the best way to judge whether recession looms is to look out the window.

Bearing in mind that anyone under 25 has never seen a severe recession, and that anyone under about 40 probably wasn't paying much attention in 1991, let me give you a hint: they don't look anything like what you see around you.

What the self-styled experts on "technical recessions" don't tell you - perhaps because they don't know - is that employment is falling and unemployment climbing rapidly during actual recessions and even before the "technical recession" is proclaimed by a slavering media.

Think about it: rapidly climbing unemployment is the main reason those of us who've lived through a few recessions don't toss the word around lightly.

So what do we know about the employment story in Sydney and Melbourne?

According to the Bureau of Statistics monthly survey of the labour force, over the year to October total employment in NSW rose by 39,000, while the rate of unemployment fell by 0.6 percentage points to 4.9 per cent (although this was fully offset by a fall in the rate of participation in the labour force).

Not all that wonderful, but a long way from the precursor to a recession.

As for Victoria, it's performance is pretty good: total employment up by 109,000 over the year to October, with the unemployment rate down 0.3 percentage points to 5.7 per cent, even while the participation rate rose by 0.9 percentage points.

If you live in Perth, however, looking out your window would convince you the West Australian economy is in something like a recession.

Over just the six months to October, employment has fallen by 19,000 (1.4 per cent) while the unemployment rate rose 0.7 points to 6.4 per cent and the participation rate fell by 0.9 points.

Get it? If we were in or near recession, you wouldn't need the technical brigade to tell you.

The other point is that most of the weakness in the nationwide figures comes from the very tough times in the 15 per cent of the national economy represented by WA - which, of course, is bearing the brunt of the massive fall-off in mining and natural gas construction activity.

NSW and Victoria aren't doing too badly.

But why the sudden sharp contraction in the national figures? The bureau's national accounts for the September quarter show that the 0.5 per cent contraction lowered the economy's annual rate of growth to 1.8 per cent, down from 3.1 per cent over the year to June.

Michael Blythe, chief economist for the Commonwealth Bank, offers the most enlightening metaphor, saying the economy had just hit a pothole.

Paul Bloxham, his opposite number at the HSBC Bank, says the fall reflected an (unusual) accumulation of various one-off factors.

"First, export growth was weak, as coal production was disrupted by a roof collapse at a key mine, and various other factors," he says.

"Second, residential construction fell in the quarter, which the statistics bureau noted was due to inclement weather.

"Third, there was a sharp fall in public investment spending, which followed a sharp rise in the June quarter.

"Finally, mining investment continued to fall as projects are being completed."

It's clear the first three of these are just temporary setbacks. "Export growth is expected to bounce back strongly in coming quarters, given that there is substantial capacity still to come on line in the resources sector, particularly liquid natural gas export facilities," Bloxham says.

Exports of services rose in the September quarter and are expected to continue to rise, supported by demand from Asia.

In home building, there's a substantial pipeline of work yet to be done on new apartment projects, which should keep housing construction growing in coming quarters, although this will come to an end after that.

The sharp fall in public investment is unlikely to be repeated next quarter. Capital spending by the public sector is, to be technical, "lumpy" - it jumps around from quarter to quarter. In this case the figures were distorted by the privatisation of a big asset.

This is the 12th quarter in a row that business investment spending has fallen because of the end of the mining construction boom.

Since December quarter 2012, mining investment's share of gross domestic product has fallen from its peak of 9.4 per cent to 3.4 per cent.

This says we can't be far from the bottom, which is good news. Bloxham says mining investment should level out - and thus stop making negative contributions to growth - around the middle of next year.

Anything's possible, but a second negative quarter seems unlikely.

Even so, when you look behind all the one-offs, you do see signs in these accounts that the economy may not be growing quite as strongly as we formerly thought.

Growth in consumer spending has been on the weak side for two quarters in a row, even though the bureau's latest stab at the household saving ratio (as a proportion of household disposable income) says it's down to 6.3 per cent, quite a bit lower than we thought. Low growth in wage rates is taking its toll.

In November, the Reserve Bank's forecast showed the economy continuing to grow by about 3 per cent next year, strengthening to about 3.5 per cent by the end of 2018.

My guess is, when we see the revised forecast in February, it will be down a bit on that, though not by a lot.

Wednesday, December 7, 2016

Why I'm a pathological optimist, in spite of my job

Last week in front of 1400 people at a Fairfax Media subscriber event I was outed as a "pathological optimist" by an anonymous reader, who wanted to know how I got that way.

It reminded me of Dylan Thomas, who went into a pub in America and got beaten up by some big bruiser – a future Trump voter, no doubt – for calling him heterosexual.

But, since you ask, I'll tell you – much as I hate talking about myself.

I think it's partly heredity, and partly by choice. When you grow up in the Salvos, professing to be "saved", it's natural to be happy with life and confident Someone Upstairs will look after you.

My mother was an incessant worrier and I grew up seeing her worrying about a lot problems that never eventuated. My father wasn't a worrier. I decided to take after my dad.

In truth, as optimists go I'm out and proud.

I can only guess at what the future holds, but people are always asking for my prediction.

If you want a forecast that errs on the optimistic side, I'm your man. If you want death and destruction, feel free to take your business elsewhere.

Many people switch between economic optimism and pessimism depending on whether they approve of the present government. Not me.

Of course, if I thought we were staring recession in the face I'd say so. Even if I thought the possibility was a lot higher than normal I'd say so – though I'd keep the announcement sober rather than sensational.

Most of the time, however, the safest and most likely prediction is that next year will be much the same as this year. When it's a half full/half empty choice, you know which way I'll jump. (You know, too, that an economist is someone who thinks the glass is twice as big as it needs to be.)

What I said at that event last week was that I'm an optimist because "it's easier to get through life that way".

It's true. I commend it to you. And I have scientific proof. Professor Martin Seligman, of the University of Pennsylvania, a founder of the positive psychology school and author of Learned Optimism, has written that optimism and hope are quite well-understood, having been the object of thousands of empirical studies.

They "cause better resistance to depression when bad events strike, better performance at work, particularly in challenging jobs, and better physical health".

Other research has shown that individuals who profess pessimistic explanations for life events have poorer physical health, are prone to depression, have a less adequately functioning immune system and are more frequent users of medical and mental healthcare.

A study by Toshihiko Maruta and others at the Mayo Clinic, which followed almost 450 patients over 30 years, found that optimists lived longer than pessimists and reported better physical and mental health. Wellness is attitudinal, not just physical.

My conclusion is that optimists live happier lives than pessimists. But are optimists happier people or are happy people more optimistic? Bit of both, is my guess.

Which is not to say optimism is rational or realistic. It isn't. Seligman defines optimism as a style of explaining life events.

Pessimists think the bad things that happen to them are permanent ("the boss is a bastard") whereas optimists think they're temporary ("the boss is in a bad mood").

Pessimists think the good things that happen to them are temporary ("my lucky day") whereas optimists think they're permanent ("I'm always lucky").

Pessimists have universal explanations for their failures ("I'm repulsive") whereas optimists have specific explanations ("I'm repulsive to him").

But don't knock self-deluding optimism. It's a motivating force for innovation and entrepreneurial endeavour and it keeps the capitalist system turning.

Business people invent new gismos and launch new products because they're convinced the new thing will be hugely successful, making their name and fortune.

Few succeed. Most do their dough. But the ones who do succeed make us more prosperous than we were. Then they try again.

But I confess my optimism is part professional calculation. As a commentator I have a contrarian streak. When all my competitors are saying black, I look for a way to say white.

This isn't hard or contrived because the media have an inbuilt tendency to predict the worse, believing this will please the audience and make them more popular.

Journalists believe our audience finds bad news more interesting than good news. For sound evolutionary reasons I've discussed before, this is right.

But ever intensifying competition has prompted the media to go over the top in their search for the big and bad.

Trouble is, most readers are optimists like me. They want to sustain their belief that, despite the bad things happening, the world is still fundamentally good, Australians are basically decent people despite some recent lapses, and life will get better, not worse.

I fear the bad-worse-worst news formula may be too depressing for some people, prompting them to switch to Facebook and photos of their friends' latest holiday.

If that's how you feel, dear reader, I'm here to help.

Monday, December 5, 2016

Education efficiency should start with Grattan compromise

If Treasury wants to start acting more like economists than accountants, a good place to start would be to urge its political masters to seize on the opportunity presented by the school funding "compact" proposed by the Grattan Institute.

Treasury advice would be much improved if it switched its approach to the budget from helping the politicians cook up some quick cuts to government spending to a more medium-term focus on achieving better value for the taxpayers' dollar through greater efficiency and effectiveness.

A more medium-term approach allows greater scope for micro-economic considerations to be incorporated into decision making.

The policy quagmire of school education is crying out for Treasury's guiding hand. It's hard to believe that school funding is still dogged by century-old sectarian rivalry between the public, Catholic systemic and independent school systems.

Thanks to this unending rivalry, the nation spends almost all its time arguing over how public funding is shared between the three systems, leaving little time to debate how well the money's being spent and how it could be better spent.

Meanwhile, domestic performance measures (NAPLAN) show, at best, no improvement in our performance over time, and international measures (PISA) show other countries improving while we mark time.

Our results show a wide gap between our best and worst performing students, which hasn't changed much, neither because our best have got better nor because our worst have got less worse.

Is this something Treasury is happy to see roll on? One unlikely to have much adverse effect on either the budget balance or national productivity?

Well, if we keep putting most of our energy into public versus Catholic versus independent, rest assured it will.

The Gonski funding review came up with a breakthrough proposal to rise above sectarian squabbling by moving to the division of combined federal and state funding on the basis of student need, regardless of which silo a disadvantaged student was in.

The Gillard government belatedly introduced a bastardised and far more expensive version of "Gonski", which the Abbott government pretended to support but disavowed immediately on winning office.

So the sectarian standoff remains. The Coalition isn't prepared to implement Labor's version of Gonski because it's too expensive, but it's too expensive because of Labor's promise to help the poor schools (those with many disadvantaged students) at no cost to the rich schools (those with few disadvantaged students).

Trouble is, until we direct more funds to the disadvantaged students, we don't stand much hope of improving our schooling outcomes.

Of course, a more efficient allocation of funds is just the first step towards improving the outcomes of disadvantaged students –  which is why it's so important to move the debate on from how the money's divided to how effectively it's being spent.

Clearly, moving to needs-based funding is as much about efficiency as about equity (fairness).

It makes zero economic sense to continue overfunding some students while those you underfund become an underclass of poorly educated workers who spend a lifetime in and out of employment, making a weak contribution to national productivity (not to mention being a recurring drag on the budget).

The 2014 budget did nothing to correct the maldistribution of federal funding to public and private schools, it just cut the basis of annual indexation from a high rate set by the Gillard legislation to just the consumer price index (much less than the rise in teachers' wages). It was about cost shifting, not reform.

This was always unsustainable politically. In the end, Malcolm Turnbull relented and promised to keep the original funding arrangement going for another three years to 2020.

Turns out grants are set to grow by 3.6 per cent a year, whereas teachers' salaries are more likely to grow by 2.5 per cent.

The genius of the "circuit-breaking new compact" proposed by Peter Goss and Julie Sonnemann of the Grattan Institute is that it seizes this rare chance to propose a deal that would get all schools up to 95 per cent of needs-based funding (the "schooling resources standard") by 2023, much earlier even than Gillard's plan.

This would involve schools below the 95 per cent benchmark having their funds raised by 3.6 per cent a year, while those between 95 and 100 per cent of the standard would rise by 2.5 per cent and those already above the standard would mark time.

This last element is the compact's point of political vulnerability, of course, and already Labor has found it.

Put the Labor opposition's personal ambitions ahead of the interests of disadvantaged students? Why not, says Labor's spokeswoman, the not so lovely Tanya Plibersek.

Let's hope Treasury has higher principles than Labor.

Saturday, December 3, 2016

Many guesses why productivity may have stopped improving

Conventional economics is falling apart, no longer making the sense we thought it made. Economists are entering a period of puzzlement and uncertainty, while their high priests struggle to hold the show together.

You can tell all that if you read between the lines of the Productivity Commission's discussion paper launching its inquiry into Increasing Australia's future prosperity, published last month.

It’s meant to be the first five-yearly review of our productivity performance, the micro-economic equivalent of Treasury’s (misnamed and now politically hijacked) five-yearly macro-economic intergenerational reports.

So it has potential to be a big deal. If you missed hearing about the discussion paper it may be because it was overshadowed that week by something that happened to a Mr Trump.

The commission opens its discussion with the alarming observation that "there is a justified global anxiety that growth in productivity – and the growth in national income that is inextricably linked to it over the longer term – has slowed or stopped".

Productivity is a measure of an economy's (or a business's) ability to convert inputs of resources into outputs of goods and services.

We commonly (and least inaccurately) measure it as output per unit of labour input – per worker or per hour worked.

But the commission prefers to measure it as output per unit of both labour and capital inputs, which it calls "multi-factor productivity". This is intended to be a measure of the essence of productivity improvement: technological advance and increased human capital.

Trouble is, the commission says, "since 2004, multi-factor productivity has stalled, here and around the developed world. This is a long enough period to suggest something is seriously awry in the economic fundamentals and the consequent generation of national wealth and individual opportunity."

Actually, by the commission's own figuring, Australia's labour productivity in the "12-industry market economy" improved by 1.9 per cent in 2014-15, the most recent year available, and our multi-factor productivity improved by 0.8 per cent, which was also our average rate of multi-factor improvement over the previous 40 years.

It's true, however, that our multi-factor performance has looked pretty sick since the turn of the century.

But the first point to note is that the problem is global, not just some weakness of ours – a fact a lot of those who've used our weak numbers to push their own favoured "reforms" have often failed to mention.

Next point, which is also often not mentioned: economists can't measure multi-factor productivity with even remote accuracy. That's mainly because they can only guess at the contribution one unit of physical capital (whatever that is) makes to production.

So it's hard to be sure the weak multi-factor productivity figures most developed countries are producing are real.

Next, assuming they are real, economists can only guess at the factors causing them. There's a lot of guessing going on by some of the world's top economists, but as yet there are no policy changes we could make with any confidence that they'd fix the problem.

Our eponymous commission produces an annual update on our productivity figures but, though it's been wringing its hands for years, its analysis has never once been able to put its finger on a causal factor we could do something about.

The few explanations it's found are either temporary or nothing to worry about.

The discussion paper acknowledges, but then dismisses, the argument of those wondering if the whole "problem" is merely a product of monumental mismeasurement.

I don't dismiss it. Had the economists not assured us of the opposite, most of us would look at the wonders of the digital revolution and the many industries being hit by digital disruption and assume the productivity indicators must be going gangbusters.

How can we be sure they aren't? One of our most thoughtful economists – one who's always gloried in digital advances – is professor John Quiggin, of the University of Queensland.

Quiggin argues that the economists' conventional model for thinking about the economy and how it grows is based on an industrial economy, which made sense in the 19th and 20th centuries, but is becoming increasingly outmoded and misleading.

We focus hard on the production of goods – agriculture, mining and manufacturing – but are vaguer about the production of services, which is the main part of the economy that's growing.

Today, he says, the primary engine of economic development is information, but information has radically different characteristics to a physical good or a service such as a haircut.

Information is often free ("non-excludable", as economists say) and it can't be used up ("non-rivalrous").

This outdated, industrial-age way of thinking about growth and productivity is reflected in the way we define and measure the economy and productivity via gross domestic product.

For instance, we measure only economic activity in markets, meaning we exclude all the activity taking place in households, and can't measure the productivity of the 20 per cent of GDP created in the public sector, including such minor industries as health and education.

And we ignore one of the most valuable outcomes of the greater prosperity that is the Productivity Commission's god: hours of leisure.

None of this, however, will stop the commission using its ultimate report to advocate a bunch of "reforms" intended to improve our small corner of the world's alleged productivity problem.

As we speak, Canberra's second biggest industry – the lobbyists – are busy churning out their self-interested submissions to the inquiry, advocating such radical new ideas as cutting company tax and weekend penalty rates.

To be fair, the commission says it's "particularly interested in new and novel ideas because there is already a strong awareness of many reform options that parties would like to see implemented. More of the same is not likely to be helpful."

We'll see how far it gets with that fond hope.

Wednesday, November 30, 2016

The Game of Mates we never quite notice

Not long after he arrived at Sydney Cove as a convict on the First Fleet, James Ruse was granted Australia's first parcel of private land – 30 acres in the heart of Parramatta – by governor Arthur Phillip.

Establishing private property rights in land is one of the core powers of government to this day. Britain had imposed limits on how much land Phillip could give away, but he had discretion over who he gave it to.

He seems to have taken a shine to Ruse, or maybe Ruse knew how to keep in his good books.

Three years later, Ruse sold his original grant for £40. A year later he was given 140 acres. Then another 16 acres, three years later.

The following year he sold these lands for £300. Twenty-one years later, aged 60, he obtained another grant of 100 acres at Riverstone. Altogether, he was given land value equivalent to about 20 years' wages for an English worker. In today's terms, about $1.5 million.

All this is recounted in the book, Game of Mates: New Masters of Australia, by Paul Frijters and Cameron Murray, to be launched on Friday.

Frijters, one of the most promising academic economists in the country, was a professor at the University of Queensland, but some of his research mightily offended the Brisbane establishment, so now he's off to a better job at the London School of Economics.

The book is his parting gift to Australia. He argues that a small class of well-connected operators hanging around the levers of government power are lining their own pockets at the expense of the rest of us.

Since Ruse was the first of them, he names each of these villains James. Frijters wants us to meet his archetypal modern James.

"He is a charming Queenslander who went to the right school, was president of the student union and has both politicians and top civil servants in his contact list. He is a professional in the Game of Mates.

"James is a clever man. When the 1980s housing boom began driving up the prices of houses throughout Queensland, he pinpointed a way to leverage the price gains for himself."

James' genius was to recognise that politicians and bureaucrats were truly in control of the gains from the influx of money for housing.

"It took political decisions to decide where new houses could be built. It took bureaucratic decisions to decide who would get permission to build bigger houses and larger apartment buildings.

"James set to work, using some of the money from his family's wealth to get started. He bought large plots of land just where one would not think the cities would expand and he set to work on the politicians and bureaucrats he knew.

"He spent time with them, shared parties and business dealings with them. He made some of them partners in his firm and, in turn, James' friends were appointed on boards deciding on planning decisions.

"Befriended politicians ran with slogans pronouncing that James' wishes were opportunities for their region, rather than costs to it.

"The politicians were later rewarded with consulting jobs to James and his friends' companies."

Get it? A Game of Mates doing what mates do, look after each other. I do you a favour and maybe one day you'll do me one.

Frijters argues this game is played in many more areas than land zoning. It can be played wherever government departments are supposedly regulating the activities of powerful industries in the interests of the public.

How many times have we seen politicians and top bureaucrats retire, but then pop up a few months later on the board or as a consultant to one of the companies they used to regulate?

How many times have we seen lobbyists brought in to head departments that regulate particular industries?

Frijters says the game has four main elements. First, flaws in our laws and regulations that create an economic honeypot to be snatched.

Second, the need for James and his mates to work as a group to capitalise on these flaws by establishing their networks of favour-exchanges.

Third, they need a way to signal loyalty to the group, a way for new members to join, and a way to rid themselves of traitors.

Fourth, they need to shield their true actions from public scrutiny with plausible myths suggesting James' dodgy dealings are good for Australia.

Frijters stresses that people playing this game aren't necessarily acting illegally, and in that sense may not be corrupt.

"The rules surrounding conflicts of interest, cooling-off periods for politicians [before they begin] working in industry, and exercising political discretion, are weak in Australia," he says.

What can we do to stop the game? "Our basic advice is to charge James for the privileges he trades in his Game of Mates or to establish a public competitor to supply the product he sells ourselves.

"We should charge him for the value increase on his houses. Charge his bank for the profits made by collusion, or introduce real competition by a true state bank. Charge his mines for the value pumped out of our ground. Charge him proper taxes. Set up a state superannuation fund . . . to compete with private ones."

Just as well you're leaving the country, Paul.

Monday, November 28, 2016

Smarter thinking on budget is long overdue

I've been writing about the federal budget for 43 years, for 28 of which it's been in deficit.
So almost two-thirds of my career has been spent backing up Treasury in its recurring campaigns to pressure the government of the day to get the budget back to surplus. Sorry, not any more.
I've resigned from the budget-hectoring brigade because it finally dawned on me there has to be a better way.
You can put the blame for our eternally recurring budget crisis on the voters, whose demand for increased government spending is limitless, but whose willingness to countenance either spending cuts or tax increases is tiny.
Or you can blame the pollies – on both sides – who spend every election campaign pandering to and thus reinforcing this unreal thinking.
They wait until after elections to spring the bad news about the laws of arithmetic, then wonder why it's so hard to be economically responsible.
But I think some of the blame has to be shared with Treasury and Finance. It's true that treasuries – state as well as federal – accept ultimate responsibility for getting the budget back to balance. They care about budget balance above all other policy objectives.
Which is just as well. If Treasury didn't accept ultimate responsibility for fiscal rectitude, who do you reckon would? Certainly not the politicians, nor the media, nor the electorate.
That's why for so long I was happy to throw my puny weight behind Treasury's budget-repair campaigns.
I've stopped because, in all that time, there's been no sign of a learning curve. Treasury goes about attempting repair of the budget in just the same primitive way it did in the mid-1970s.
In all that time it's learnt almost no new tricks. It's applied no new science to its core responsibility of expenditure control, just kept on with the same old, same old simplistic cost-cutting approach.
Economists elsewhere have come up with inventive ways to make government spending more efficient and cost-effective: income contingent loans, activity-based health funding, the investment approach to welfare spending, early learning and other preventive programs, rigorous program evaluation and more.
Some of these techniques are being used in the federal budget, but not to the extent they should be and, to my knowledge, not because they were long championed by Treasury and Finance.
Indeed, it wouldn't surprise me if some had been opposed, or long-term investment in preventive medical programs sabotaged for a quick saving.
The best Treasury has come up with is the Orwellian annual "efficiency" dividend imposed on departments and agencies, and the rule that departments proposing new spending programs must also propose offsetting spending cuts of equivalent value.
Both crude devices have been relied on year after year, to the point where their economies are more likely to be false ones.
The efficiency dividend has become a euphemism for indiscriminate compulsory redundancies, which has robbed Treasury and Finance, and even the spending departments, of many of their policy experts.
Not to worry. If we need policy advice we'll buy it from one of the big accounting firms. They'll pretend to know what they're talking about and cost a fortune, but can be relied on to give us the recommendations we were hoping for.
The offsetting-savings rule has turned inefficiencies into valuable currency, to be husbanded jealously by their departments and given up only in return for equivalent spending increases.
It transfers responsibility for finding efficiencies away from the co-ordinating departments and into hands of departments just as likely to have been captured by the business interests they're supposed to be regulating.
The accountants of Finance can hardly be blamed for thinking like accountants. Trouble is, Treasury people too often think and act like accountants rather than economists.
They tend to view spending control as an annual scramble to knock the budget into shape, not a medium-term exercise in delivering value for money to the citizenry the government serves.
Too often they fail to consider the broader economic consequences of the cuts they push through. Like accountants, they think in terms of chopping spending down to the required size, not improving the efficiency and effectiveness of government service delivery.
They bang on about the nation's poor rate of productivity improvement while forgetting they themselves possess considerable scope to raise the efficiency of two of the economy's biggest and fastest growing industries, the two spending areas that dominate combined federal and state budgets and that will, unless made more efficient, do most keep budgets in crisis for decades to come: education and health.
No, no, leave that to the departments – or the other level of government.

Saturday, November 26, 2016

Reduced competition may be slowing US growth

US financial markets may be betting that the Trump administration's budget policies will stimulate economic growth and inflation, but they're cheered by this prospect only because of deeper fears that America and the advanced economies have entered an era of persistently weak growth.

America's rate of growth has been slowing for decades, starting long before the onset of the global financial crisis.

As part of this, America's rate of productivity improvement has been weakening, despite a short-lived uptick in the 1990s.

So the hunt's been on for factors that may be causing this slowdown. There are many suspects. But one you often see mentioned by economists such as Professor Paul Krugman is a decline in the strength of competition in many American markets.

If markets are significantly less competitive, you'd expect this to mean consumer prices that are higher than they might be, profits that are higher, less innovation, slower productivity improvement, worsening inequality and slower growth.

But what's the evidence of reduced competitive pressure? Earlier this year President Obama's Council of Economic Advisers issued a paper reviewing the evidence, which I'll summarise.

There are various ways to measure the degree of "concentration" in an industry – that is, how much of the business done by an industry is captured by a small number of large firms.

Figures collected by the US Census Bureau show that, over the 15 years to 2012, the share of total sales revenue earned by the 50 largest firms in 13 broad industry categories fell in three, was unchanged in one but increased in nine.

If 50 sounds like a lot of firms, remember this is America, whose economy is about 12 times bigger than ours.

Sales concentration was highest among utilities – electricity, gas and water – at 69 per cent, which isn't surprising considering many are natural monopolies. Even so, concentration increased by almost 5 percentage points.

After that came finance and insurance, where concentration was up by 10 percentage points to more than 48 per cent, followed by transportation and warehousing (up more than 11 points to 42 per cent) and retail trade (up 11 points to 37 per cent).

This picture is confirmed by studies of specific industries, the briefing paper says. One study of the national market for loans found that, over the 30 years to 2010, the top 10 banks' market share increased by 20 points to 50 per cent.

For deposits, the market share increased from 20 per cent to almost 50 per cent.

Another study found that, for hospital markets over the decade to 2006, a common measure of concentration increased by about 50 per cent, to a degree equivalent to having just three equal-sized competitors in a market.

A different measure of possibly reduced competition comes from looking at what's happened to the rates of profitability of big firms.

When researchers take the rates of return on invested capital for listed US companies, then rank them from highest to lowest, they find that for firms at the 90th percentile (that is, 10 per cent down from the top; 90 per cent up from the bottom) their rate of return is five times higher than for the median (dead middle) firms.

A quarter of a century ago, the 90th percentile firms' rate of return was closer to twice the median firms'.

This suggests some firms are better able to extract "economic rent" than they were. Economic rent is the profit you make that exceeds what you'd need to earn to be willing to remain in the industry.

Yet another indication comes from the "long-term downward trend in business dynamism", as indicated by a steady decline since the late 1970s in the proportion of new firms entering markets each year.

This is while the proportion of firms exiting markets each year has been little changed. Since the entry rate has now fallen to be equal to the exit rate, the total number of firms – which used to grow by about 6 per cent a year – is now unchanging.

Part of the explanation for the decline in the number of new firms could be rising "barriers to entry" into many industries.

This could be caused by increased federal, state or local licensing requirements, ever-rising economies of scale or data-mining information advantages to incumbent firms, or successful lobbying for government rules to protect against new entrants.

Labour market dynamism – how often workers change employers – has also declined since the 1970s.

This could have many causes, including no-poaching agreements between employers and greatly increased occupational licensing, which limits people's freedom to move between states.

The briefing paper notes it's not yet clear how these various indicators suggesting the US may be suffering a fall in competition within its markets fit together.

Turning to possible causes of reduced competition, it notes the problem of "common ownership". Researchers have argued that institutional investors who are large owners of the biggest firms in a particular industry, implicitly encourage those firms not to compete with each other, thus raising the investors' profits.

According to other research, the role of institutional investors has grown over the past 30 years so that, in 2014, they controlled 61 per cent of worldwide investment assets.

One anti-competitive development the briefing paper doesn't mention is the US Congress's willingness to keep extending the lives of existing and future patents and copyright.

Meanwhile, US government trade negotiators use bilateral preferential trade deals – going by the Orwellian name of "free trade agreements" – and plurilateral deals such as the Trans-Pacific Partnership agreement to press partners like us to extend the lives of our patents and copyright to fit with the Yanks' domestic arrangements.

Maybe one reason economic growth is slowing is that the world's multinational corporations are getting too good at finding ways to inhibit competition between them, including by enlisting the help of governments.

Wednesday, November 23, 2016

'Nanny state' is cover for exploitation by commercial interests

Oh no, the nanny state brigade is at it again. In their certainty they know what's best for us, they're back with their social engineering, wanting to punish us for being fat and use a tax on sugary drinks to push us towards "healthier choices".

On Wednesday the Grattan Institute will release a report urging the federal government to impose an excise of 40¢ per 100 grams of sugar on non-alcoholic beverages that contain added sugar.

What part of personal freedom don't they understand? If people want to drink sugary drinks, why should anyone else try to stop them? What harm are they doing to others?

Surely this is a matter of personal choice and responsibility. If being fat is bad for the health, it's up to the individual to accept responsibility for their own fate and decide to eat less and exercise more.

How much of our lives is the government going to take over? What willpower will be left if they keep doing more of this stuff?

Actually, I'm never convinced by these arguments from the professed defenders of our personal liberty.

Whenever I hear people banging on about "the nanny state" I wonder about their motives. Many of the critics are trying to keep government small so they're required to pay less tax.

These souls are often full of their own virtue. They attribute their comfortable circumstances entirely to their own efforts (forgetting the outside help they invariably had) and can't see why they should help others who aren't as disciplined as they are.

As for the libertarian think tanks leading the charge against the nanny state, you wonder how many of their undisclosed (but tax deductible) donations come from alcohol, tobacco and food companies anxious to resist any government measure limiting their freedom to profit from unhealthy products.

As the Grattan report – written by Hal Swerissen and Professor Stephen Duckett, a leading health economist – reminds us, there's little doubt that excessive overweight increases the risk of premature death, diabetes and cardiovascular disease.

Yet the incidence of obesity – a body mass index of more than 30 – is growing in the rich countries. The proportion of obese Australian adults is 28 per cent, up from less than 10 per cent in the 1980s. That's not counting the further 36 per cent who are overweight.

About 7 per cent of Australian children are obese, up from a negligible number in the '80s.

Although it may have plateaued among children, obesity continues to worsen among adults and seems likely to increase further.

Research suggests the main cause is overeating of processed food laced with sugar, fat and salt, which grows ever cheaper and available. The amount of exercise we get hasn't changed much over that time.

Health authorities and governments have been worried about an "obesity epidemic" for years, but nothing they've done so far seems to have worked.

This is probably because they've been tiptoeing around the powerful commercial food interests, focusing on individual responsibility, physical exercise and voluntary food labelling.

I agree it's time we did something more assertive and, though a tax on sugary drinks is far from a cure-all, it's a good place to start.

Lots of other countries are doing it, and have shown it works in discouraging consumption of sugary drinks and reducing obesity somewhat.

For us to impose it as a federal excise would be simple and administratively cheap. We already have excises intended to discourage us from smoking and overconsuming alcoholic beverages.

It would be paid by manufacturers and importers, then passed on to consumers, which would encourage people to move to bottled water, artificially sweetened drinks or even tap water.

A principle of libertarianism is that you should be allowed to do as you please as long as you're not harming others.

But as well as harming themselves, the obese also harm the rest of us. Evidence shows that, relative to others, the obese make more use of doctors, hospitals and pharmaceutical benefits.

All these impose higher costs on other taxpayers. Obese people are more likely to be on welfare benefits and less likely to be employed and paying income tax, which imposes further cost on other taxpayers.

Grattan estimates the cost to the rest of us is about $5 billion a year. The sugary drinks tax would recoup about $500 million a year of that.

Libertarianism assumes no one could possibly know our best interests better than ourselves. That's because we are unfailingly rational in the decisions we make. We have an iron will which stops us doing anything we later come to regret or being influenced by the behaviour of those around us.

In reality, all of us have a problem with self-control in at least one area of our lives and probably several.

And here's the bit nanny's critics never get: most of us are pleased when governments help us with our self-control problem by taking temptation out of our way.

Governments have used compulsory seat belts and random breath testing to reduce road deaths per head of population by more than 80 per cent. They've used sky high tobacco tax, bans on indoor smoking and other things to cut the rate of smoking by more than half.

It's high time they stood up to the processed food industry and did something effective about obesity.

Monday, November 21, 2016

Our politicians go populist at their peril

If I were an Australian politician I'd think hard about the ascension of Donald Trump before I drew conclusions for local consumption.

When someone so unattractive surprises us by winning, it's tempting to conclude he must have done so because of a massive surge of anger over immigrants, Muslims and jobs lost through trade agreements.

We connect this with the Brexit surprise and the resurrection of One Nation and conclude we're witnessing a worldwide populist uprising against globalisation and "neo-liberalism".

Pollies on both sides wonder whether they should protect their backs by reverting to more protectionist policies, rejecting more Chinese investment and shouting louder about Australia-first.

But such a reaction much exaggerates the popularity of populism in America – as is clearer now more of the vote has been counted.

First, note that Hillary Clinton got over a million votes more than Donald Trump did. He actually got fewer votes than Mitt Romney in 2012 and John McCain in 2008.

How is such a wide discrepancy between the popular vote and the electoral college result possible? Because the many smaller states get a disproportionate number of votes in the college.

So Trump won because he got more votes in the right places – three or four smaller "swing states" in the midwest Rust Belt, which normally vote Democrat.

It's true Trump won these states because enough white males without college educations found his plain-talking and promise to "make America great again" – that is, bring jobs back to the Rust Belt – more attractive than establishing a Clinton dynasty.

But let's not kid ourselves America is seeing a nation-wide upsurge in populist protectionism, any more than One Nation's ability to exploit an ill-judged double dissolution represents an existential threat to Labor or the Coalition.

Next, remember populist sentiments can't be satisfied. They're about the expression of emotion – anger, frustration, envy, fear of foreigners, resentment of city-slickers and the better-educated – not about rational choices.

They're about wishing the world hadn't changed and wishing some saviour could change it back.

Populism is about ignoring the things that have changed for the good – such as much lower prices for clothes, groceries, hardware, electronic goods, cars and much else – and assuming we can reverse the changes we don't like without losing the benefits we've come to take for granted.

Populism is about explaining the decline in employment in manufacturing, and the shift in economic activity from the Rust Belt to the Sun Belt, solely in terms of free-trade agreements – which were made by governments and so supposedly can be reversed – while ignoring the much greater role played by technological change, which happened in spite of governments and can't be stopped by governments.

It's perfectly possible for America to make no further trade agreements, but only an American could delude themselves that their government could tear up longstanding agreements with other countries while those countries sucked it up.

Protectionist moves lead to retaliation by your trading partners. That leaves both sides worse off.

Consider all the wild promises Trump made to con the Rust Belt's white male workers into voting for him: a wall along the Mexican border, a 35 per cent tariff on Mexican imports and 45 per cent on Chinese imports, plus renegotiation of the North American free-trade agreement.

Assuming he wanted to, he can't actually do these things. Assuming somehow he could, they wouldn't fix the problem the way his dupes imagine, while introducing a new set of problems.

This says it won't be long before the Rust Belt's plain talkers realise they've been conned.

Add to them the majority that didn't want him in first place, and the many who held their nose and voted Republican because they couldn't stomach any Democrat, and it's not hard to see Trump setting records for the time it takes a president to become thoroughly on the nose.

Sound like a winning formula for our pollies to copy? Since populism fosters aspirations that can't be satisfied, it's suited to new, minor parties, but a high-risk tactic for parties that stand a chance of getting to government and having to deliver on the expectations raised.

None of this says the Rust Belt revolters don't have legitimate grievances.

A small group of business heavies and well-educated city-slickers has grabbed almost all the benefits from the structural change that's so disadvantaged the rust-belters, without governments – even Democrat majorities – doing much to oblige the winners to share with the losers.

For once in their lives, rather than going lower when they see the Yanks go lower, our pollies should, to quote Michelle Obama, "go high when they go low".

Saturday, November 19, 2016

How we've grown for so long: safety valves and buffers

How has poor little Oz managed to keep our economy growing continuously for 25 years while, in the same period, other economies have suffered a recession or even two? We've had good insurance policies.

That's the answer the new Reserve Bank governor, Dr Philip Lowe, gave in a speech this week. As he explains it, however, it's a detailed story.

Actually, there are two parts to his explanation for our economic success: the first is our good "fundamentals" and the second is our ability to ride out the various "economic shocks" that hit every economy from time to time.

Lowe lists our good fundamentals as including our abundance of natural resources, our well-educated workforce, our "generally favourable demographics" (I think he means our growing population and that our ageing population isn't too aged), our openness to international trade and investment, our links with the fast-growing Asian region, and our demonstrated ability to reform the structure of our economy to boost its productivity.

Lowe adds that the reforms of the 1980s and '90s have given us a more flexible economy, one better able to roll with the punches than it used to be. He nominates three key areas of greater flexibility: our exchange rate, our conduct of monetary policy and our labour market.

Since we allowed our dollar to float in 1983, it has generally moved up or down in response to developments in ways that tend to limit inflation pressure and to stabilise growth.

Since we decided in the mid-1990s to let the central bank - rather than the politicians - make decisions about when to increase or decrease interest rates, as guided by the target of keeping inflation between 2 and 3 per cent on average over the medium term, we've kept the inflation rate reasonably stable and minimised swings in unemployment.

Since we ended the centralised wage-fixing system and moved to collective bargaining at the enterprise level in the first half of the 1990s, we've avoided wage inflation, kept real wages rising in line with improvements in productivity (until recently, anyway) and made employers less inclined to respond to downturns with mass layoffs.

These great areas of flexibility - the floating exchange rate, the independent, target-based approach to monetary policy (interest rates), and enterprise-based wage-fixing - have helped us avoid being derailed by economic shocks.

And it's not as if there's been a shortage of such shocks that could have derailed us, Lowe says.

First, there was the Asian financial crisis of 1997-98, which did derail some of our Asian trading partners. Then there was the bust of the US tech boom - the Tech Wreck of 2001 - then the global financial crisis of 2008-09.

 As well, there's the resources boom. With its once-in-a-century surge and then collapse in coal and iron ore prices and consequent surge and falloff in mining construction, the resources boom was a massive, decade-long shock to our economy.

Australia's economic history is littered with commodity booms soon leading to recessions, but not this one (except in Western Australia, thanks to mismanagement by its state government).

But all that's just by way of background. Lowe's main point is to draw attention to the way our possession of certain "buffers" absorbs some of the blow when shocks hit.

We build up and hold these buffers as a kind of insurance policy against the day when trouble arises. Like all insurance policies, they come at a cost. There's a premium to be paid.

So where do you find these buffers? On the balance sheets of banks, governments and households. They're about ensuring your assets exceed your liabilities by a decent safety margin, in case some unexpected problem arises.

In the years leading up to the global financial crisis, our banks maintained higher ratios - of their shareholders' capital to their lending to borrowers - than did banks in America and Europe.

That's why our banks were able to keep lending after the crisis, whereas the others weren't. Their inability to keep lending amplified the original shock.

In the years since then, international authorities have imposed higher levels of capital adequacy and liquidity on the world's banks, including ours.

These greater restrictions make banks safer, but also reduce their profitability. We're still waiting to see how the cost of this insurance premium will be shared between our banks' customers and their shareholders.

At the time of the financial crisis, our government had "positive net debt" - it had more money in the bank than it owed to people holding its bonds.

This made it a lot easier for our government to support the economy by borrowing and spending. Now, Lowe argues, we need to gradually move the budget from deficit back to surplus, rebuilding our fiscal buffer for the next time it's needed.

The total debts of our households have risen to 185 per cent of their annual disposable income. This is a lot higher than for other rich countries, but that's partly because unusual distortions in our tax system encourage borrowing for rental properties to be done by individuals rather than big companies.

More to the point, households have been building up buffers by using mortgage offset and redraw facilities to reduce their net debt by 17 per cent of the gross debt, in the process getting a collective 2½ years ahead of their scheduled repayments.

More than half of all households with mortgage debt, at each level of income, are ahead on their repayments.

If you subtract from our households' debt all the money they hold in currency and bank deposits, the nation's households' net debt falls to about 100 per cent of their annual disposable income.

Our household debt is high, but we've got a fair bit of buffer.