Wednesday, August 20, 2014

Abbott's economic script is out of date

It doesn't seem yet to have dawned on Tony Abbott that he was elected because he wasn't Julia Gillard or Kevin Rudd, not because voters thought it was time we made a lurch to the Right.

The man who imagines he has a "mandate" to mistreat the children of boat people, ensure free speech for bigots, give top appointments to big business mates and reintroduce knights and dames, represented himself as a harmless populist before the election.

The other thing he doesn't seem to have realised is that just as he has us moving to reduce our commitment to action against climate change and to make the budget much less fair, the rest of the advanced economies are moving the opposite way.

President Obama is taking steps to overcome Congress's refusal to act on global warming, the Chinese get more concerned about it as each month passes and the International Monetary Fund is chastising us for our apostasy.

And while we use our budget to widen the gap between rich and poor, people in other countries are realising the need to narrow it.

Wayne Swan, former Labor treasurer, noted in a speech on Monday that "centre-right political leaders across the globe are acknowledging the obvious truth that capitalism is facing an existential challenge ... only last week ratings agency Standard and Poor's emphasised yet again that high inequality is a drag on growth".

In Australia, however, an increasing "vocal minority has decided to oppose any reform, no matter how necessary and no matter how obvious in its benefits to the whole nation, if they perceive it is in their short-term interests to do so".

"This is a recipe for unnecessary political division and widening social inequality, and unfortunately permanent reform failure," he says.

Australians had done much better than the Americans at matching strong economic growth with social equity but, according to Swan, "we're witnessing the Americanisation of the Right in this country. Obsessed with defending the advantages of the wealthiest in our society".

In his efforts to defend rather than correct his first budget's unfairness, Joe Hockey seems to be doing just that. Meanwhile, the messages from international authorities are very different.

In a recent paper on policy challenges for the next 50 years, the Organisation for Economic Co-operation and Development warned the growing importance of skill-biased technological progress and the rising demand for skills, will continue to widen the gap between high and low wages.

Unless this was corrected by greater redistribution of income, other OECD countries would end up facing almost the same level of inequality as seen in the US today. "Rising inequalities may backlash on growth, notably if they reduce economic opportunities available to low-income talented individuals," it warns.

Christine Lagarde, managing director of the International Monetary Fund, noted in a speech that the 85 richest people in the world control as much wealth as the poorest half of the global population - 3.5 billion people.

"With facts like these, it is no wonder that rising inequality has risen to the top of the agenda - not only among groups normally focused on social justice, but also increasingly among politicians, central bankers and business leaders," she said.

"Many would argue, however, that we should ultimately care about equality of opportunity, not equality of outcome." As it happens, Hockey has defended his budget's unfairness with just that argument.

"The problem is that opportunities are not equal. Money will always buy better-quality education and health care, for example. But due to current levels of inequality, too many people in too many countries have only the most basic access to these services, if at all. The evidence also shows that social mobility is more stunted in less equal societies."

Disparity also brings division. "The principles of solidarity and reciprocity that bind societies together are more likely to erode in excessively unequal societies. History also teaches us that democracy begins to fray at the edges once political battles separate the haves against the have-nots."

Pope Francis put this in stark terms when he called increasing inequality "the root of social evil".

"It is therefore not surprising that IMF research - which looked at 173 countries over the past 50 years - found that more unequal countries tend to have lower and less durable economic growth," Legarde said.

Get that? Until now, the conventional wisdom among economists has been that efforts to reduce inequality come at the expense of economic growth. Now a pillar of economic orthodoxy, the IMF, has found it works the other way round: rising inequality seems to lead to slower growth.

Lagarde said other IMF research had found that, in general, budgetary policies had a good record of reducing social disparities. Social security benefits and income taxes "have been able to reduce inequality by about a third, on average, among the advanced economies".

What can we do? "Some potentially beneficial options can include making income tax systems more progressive without being excessive; making greater use of property taxes; expanding access to education and health; and relying more on active labour market programs and in-work social benefits."

Perhaps in his efforts to get a modified version of his budget passed by the Senate, Hockey could bring in the IMF as consultants.
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Monday, August 18, 2014

Stop wasting money on infrastructure

Don't laugh too hard at the ABC's new satire, Utopia, and the wasteful and appearances-driven antics Rob Sitch gets up to as head of the Nation Building Authority. It's too close to the truth to be funny.

One of the foremost areas where governments need to lift the efficiency of their spending - as opposed to cutting payments to the needy or short-sighted cost-shifting - is infrastructure. It has become an area where too much spending is never enough and anything labelled "infrastructure" is above critical scrutiny.

In recent days, however, we've been given cause to cast a more sceptical eye over spending on capital works. Consider first the views of a highly experienced former econocrat, Dr Mike Keating: "Australia has a long history of over-investment in infrastructure, with the costs exceeding the benefits, and under-charging the beneficiaries so that they demand more and more.

"It is therefore most reprehensible that this budget prides itself that new spending decisions will add $58 billion to total infrastructure investment, when none of the projects announced have been ticked off by Infrastructure Australia as having completed proper cost-benefit appraisals, probably because a great deal of this investment never could pass any proper evaluation.

"And this from a government that was properly critical of the former government and its approach to the national broadband network. Clearly this improper use of the nation's savings is not an acceptable reason for the other budget cuts, and the increase in petrol excise should not be tied to an increase in uneconomic road funding."

Yes, indeed. It's disillusioning behaviour from Tony Abbott, who promised "rigorous, published, cost-benefit analysis" of infrastructure projects.

Last week, Garry Bowditch, chief executive of the University of Wollongong's SMART infrastructure facility, offered a sobering assessment of capital works spending, noting that cost overruns have reached between $4 billion and $5 billion a year.

Value for money is thrown out the window, he said, when governments fail to time the construction of infrastructure to make sure they're not inflating the prices of labour, materials and equipment by competing with the private sector during booms.

Adjusted for inflation, Brisbane's Gateway Bridge, built in 1986, cost about $300 million. But when a second, identical bridge was built in 2010, during the mining construction boom, it cost $1.7 billion.

Bowditch, a former econocrat, called on governments to release cost-benefit analyses for Sydney's proposed $11.5 billion WestConnex motorway and Melbourne's $8 billion East West Link tunnel.

He argued that poor long-term planning by federal and state governments, which don't communicate well with each other, had led to unnecessary costly construction methods, such as tunnels, because land corridors had not been reserved for rail and road development.

Sir John Armitt, former chairman of Britain's Olympic Delivery Authority, said we should be using technology to improve the capacity of existing rail, road and energy networks, and to prepare for driverless cars.

Good point. Politicians love cutting ribbons and announcing grand, nation-building projects. But they'd waste less taxpayers' money if they got the pricing of existing infrastructure right first, and so had a more realistic estimate of the demand for additional infrastructure. It's called efficiency.

The credibility of economic modelling by allegedly independent consultants is surely shrinking before our eyes. Not long ago we were treated to the spectacle of two leading firms of economic consultants producing diametrically opposed modelling of the cost of the renewable energy target. Why? Surely not because they were commissioned by outfits with rival axes to grind?

Last week we learnt that AMP, whose funds lost a lot of dough after the failure of the outfit owning Sydney's Lane Cove Tunnel in 2007, is suing the consultants who provided excessive forecasts of the likely traffic flows, accusing them of producing figures that were "reverse engineered" by working backward from their client's commercial objective. Surely not.

One reason it would be good to see cost-benefit analyses of the aforementioned infrastructure projects adopted by the Coalition is to test the efficiency of Abbott's insistence that he'll finance roads but not public transport.

So far the NSW and Victorian governments have done a hopeless job of limiting congestion. Since building extra motorways adds to demand rather than reducing delays, my guess is neglect of public transport is the culprit.

But the Grattan Institute's report on cities as engines of prosperity reminds us that the longer it takes people to move between home and job, the harder it is to fully exploit the "knowledge spillovers" that drive the knowledge economy. Didn't you guys say you were worried about slow productivity improvement?
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Saturday, August 16, 2014

Economists should learn some geography

One of the great failings of economists is their confident assumption that their way of looking at the economy is the only way - certainly, the only useful way - of understanding it.

For one thing, their almost exclusive focus on money - prices, actually - and their convenient assumption that people are rational, allows them to analyse an economy populated by automatons rather than fallible, flighty humans.

Behavioural economics and economic sociology attempt to correct this deficiency.

But there's another way of studying the economy that most economists take little interest in, to the detriment of their understanding of how the economy ticks: its spatial dimension. This failure is getting more costly as we move to a knowledge economy.

Why isn't economic activity spread pretty much evenly across our vast continent? Why is almost all of it concentrated around our coastline?

For most of our states, up to three-quarters of their economic activity is concentrated in their capital city, which is also the state's first site of white settlement. This is partly an accident of history. Newcomers tend to settle where other people are already settled.

But economic geographers have long known there's also a lot of economic logic to where people settle. Farmers tend to settle where the most arable land is. Mines have to be built where the minerals are.

Manufacturers have to decide whether to build their factories close to where their raw materials are or close to where their customers are. They usually decide to set up in cities, often on the outskirts of cities where land is cheaper.

What's more, many of the firms in a particular industry will gravitate to the same city, usually a big one. Why? So as to exploit "economies of agglomeration".

You've heard of economies of scale. Economies arise when similar firms agglomerate (cluster together). Workers with skills relevant to that industry are attracted to that city, meaning firms have less trouble getting the skilled workers they need. Workers who lose their jobs at one firm may not need to move house to get another job at a similar firm.

Likewise, the manufacturers and their suppliers of specialist equipment and materials each benefit by being close to each other. Firms in the same business can keep an eye on each other, copying anyone who gets on to a better way of doing things. That way, the whole industry gets more efficient at a faster rate.

All this has long been understood by economic geographers. But the advent of the knowledge economy has given agglomeration economies a major new twist and added to the economic significance of big cities, as the report, Mapping Australia's Economy: cities as engines of prosperity, by Jane-Frances Kelly and Paul Donegan, of the Grattan Institute, has pointed out.

"Today the Australian economy is no longer driven by what we make - the extraction and production of physical goods - but rather by what we know and do. Like other advanced economies around the world, our economy is continuing to become more knowledge-intensive, more specialised and more globally connected," the report says.

"Knowledge-intensive businesses - which are the most productive today - tend to cluster and thrive in the centres of large cities."

It turns out economic activity in Australia is concentrated in and around large cities, but is not distributed evenly within cities. Central business districts and inner-city areas are especially important: they represent substantial concentrations of employment, but even more intense concentrations of economic activity. In other words, CBD workers have a lot higher productivity than other workers.

The report explains that "the more highly skilled and specialised a job, the greater the need to find the best person to fill it. This is especially important when the work involves knowledge, expertise, judgment and learning".

Being close to suppliers, customers and rivals helps businesses generate new business opportunities and ideas for products and services, and better ways of working. These transfers of expertise, new ideas and process improvements that occur through interactions between businesses are called "knowledge spillovers" (a class of "positive externality").

Within cities, CBDs and inner-city areas offer the most opportunities for face-to-face contact among workers, essential to benefiting from knowledge spillovers. Spillovers often involve combining and recombining knowledge to come up with new products and ways of working.

Workers build on each other's thoughts, jointly solve problems and break through impasses. Trust is essential, and these kinds of complex conversations are best had in person.

"High-speed broadband and other advances in communication technologies will never replace the importance of face-to-face contact," we're told.

Grattan's research finds that residential patterns and transport systems mean CBD employers have access to only a limited proportion of workers in metropolitan areas. Turning that around, many workers, particularly in outer suburbs, have access to only a small proportion of jobs across the city.

For instance, in some outer suburban growth areas of Melbourne, just 10 per cent of the city's jobs can be reached within a 45-minute drive. If work journeys are made by public transport it's worse.

The report warns that, unless governments lift their game, "Australian cities are likely to continue to spread outwards, further increasing the distance between where many people live and the most productive parts of large cities". This would harm productivity - and workers' opportunity to get ahead.

The point is, governments need to understand the economy's spatial dimension and respond by ensuring transport networks better connect employees with employers, and businesses with their customers and suppliers. Continue letting congestion worsen and you cause productivity to be lower than otherwise, not to mention adding misery to people's lives.
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Wednesday, August 13, 2014

Big business now calling the economic shots

Sometimes I wonder whether the economy is being managed for our benefit or for the benefit of the big businesses that dominate it. The two big supermarket chains we get to choose between, the two domestic airlines and privately owned airports, the three foreign mining giants that were allowed to redesign the mining tax they didn't like, and the four big banks that control so much of our superannuation and the investment advice we get, not to mention our savings accounts and mortgages.

I'm old enough to remember when economic life seemed to be dominated by big unions. Hardly a month passed without our lives being disrupted by some strike. We'd be walking miles to work or finding someone to mind the kids while the teachers were out.

I remember finishing a holiday in New Zealand with our young family, only to find the baggage handlers in Sydney were on strike and being stuck in Christchurch for an extra two days.

Thank goodness we don't have to put up with all that any more. But in place of being bossed around by the unions, we now have big business calling the shots. They don't inconvenience us like the unions did, but they do seem to have the ear of government.

Big business is always complaining about some way the economy's being run that doesn't meet with its approval. It's always warning of the terrible economic price we'll pay if it doesn't get what it wants. Its complaints are always treated with reverence by the media. And always taken seriously by the government, Labor or Coalition.

We seem to be developing a new economic religion that what's good for big business is good for the country. No one believes this more fervently than the big business people themselves - plus their never-silent lobby groups.

These paragons of industry want to be unfettered in their efforts to expand their businesses and make higher profits, which they're doing purely in the interests of you and me. And they're always terribly impatient. They want to frack wherever they want to frack, they want to start tomorrow and they don't want selfish, short-sighted people to slow them down, let alone stop them.

They want to invest in a new mine or a new something which will create tens of thousands of new jobs in the district, and what other consideration could possibly trump that? If you want to consult the locals before granting permission, this is "red tape", which by definition is bad and must be swept aside. If you want time to investigate the environmental impact of the project, this is "green tape" and just as much economic vandalism as the red.

Another problem is the breakdown of "caveat emptor" - it's the buyer's job to make sure they're not ripped off. Products, particularly financial products, have become complex and hard to compare - deliberately so, you have to suspect.

In theory, we're supposed to read every word of the contracts we sign, know whether the nice man giving us advice on our savings is being paid to push some products but not others, know whether he'll go on receiving a commission for years without contacting us again, check continually to see whether our bank is now offering a better deal than we get without telling us or whether we should be moving our banking business, check what fees we're being charged on our superannuation and whether a different fund would give us a better deal.

In theory, we should devote much of our free time to doing all that. In practice, few do. We like to relax when we're not working and are diverted by an ever-multiplying range of commercial entertainments.

In practice, big business knows far more about this stuff than we do. So we need governments to protect us from being exploited, prohibiting certain kinds of behaviour, requiring financial institutions to keep us informed in ways we can understand and not take advantage of our inferior knowledge and inertia.

After many people lost their savings during the financial crisis, the previous federal government decided to tighten up on financial advice. Its original plans were modified after lobbying by the banks and their lobby groups, and now they've been watered down further by the present government - all in the name of reducing red tape.

The government compels most employees to contribute 9.5 per cent of their salaries to superannuation, from which the people running those funds extract very high fees - now equal to an amazing 1 per cent of gross domestic product - which greatly reduce final payouts.

The interim report of the inquiry into the financial system found that the fees appeared high by international standards. It found little evidence of strong fee-based competition between funds. The funds have got a lot bigger in recent years, but these economies of scale haven't led to lower fees.

The previous government introduced a new, simpler super account called MySuper in an effort to reduce fees, but the report says it's too early to assess its success in doing so. Last week, the Financial Services Council lobby group began arguing strongly that fees aren't too high. We must hope it isn't as influential in resisting the push for lower super fees as it was in getting the investment-advice protections watered down.
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Monday, August 11, 2014

Econocrats advise false economy

Joe Hockey and Tony Abbott shouldn't take all the blame for the low quality of the measures in the budget. I suspect they're victims of poor advice from the econocrats of Treasury and Finance.

Gary Banks, former boss of the Productivity Commission, says the public service's role is to inform policy choices. If so, it did an unimpressive job of informing an inexperienced government on the best way to exploit the unique political opportunity offered by the Coalition's very first budget.

We can never know exactly what advice passed between the bureaucrats and their masters, but it would be an unusual budget whose measures didn't arise from options provided by the presumed experts.

And a comment by Laura Tingle of The Australian Financial Review offers a clue: "Former Labor ministers were genuinely surprised after the May 13 budget that the new government had simply picked up the same raw policy proposals the public service had been serving up for years and included them in the budget ... It seemed no one in the new government ... recognised these as policy chestnuts from the bureaucracy's bottom drawer."

If that's right, it's an indictment of the bureaucrats' intellectual laziness and lack of expertise. It's the 21st century, but these people have sat for decades learning nothing but "here's where you could cut, minister".

A huge proportion of the spending on two of the nation's biggest and fastest-growing industries, education and health - industries whose performance has major implications for productivity and social wellbeing - passes through the federal budget, but all the budget bureaucrats have to offer is a list of things you could chop.

Since the budget measures focused almost exclusively on the spending side, and since those measures had the smell of the bookkeeper rather than the economist (economists are trained to think about subsequent, not just immediate, effects), I suspect it's Finance more than Treasury that's responsible for such a dismal performance.

What we needed were sophisticated initiatives aimed at raising the efficiency with which public services are delivered to the public.

What does the empirical literature and the experience of other governments tell us about what works and what doesn't? If Finance and Treasury aren't expert on this, why aren't they?

What we got instead were crude spending cuts - or, more often, cost-shifting. A high proportion of the savings will come merely from shunting more of the cost of education and health onto graduates, patients and the states. How much thought went into cooking that up?

The right answer to the growing cost of the Pharmaceutical Benefits Scheme, for instance, is to drive harder bargains on generics with the big foreign drug companies (which pose as Medicines Australia) and the chemists, and to force harder choices on the medicos who advise on which new drugs should be listed by giving them an annual spending cap.

So what did we get? A $5-a-pop increase in the already high general patient co-payment which, in any case, is indexed, with a smaller rise for pensioners. Could laying it on so thick discourage people from filling their prescriptions, thus worsening their health and eventually adding to public spending on healthcare?

Who knows? Who cares? No one in the budget bureaucracy, it seems. If the measure makes things worse rather than better, worry about that in a later budget. "I know, minister, let's whack up patient co-payments again. Tell 'em health costs are unsustainable."

It's a similar story with Medicare. Health economists have devised various ways of achieving greater efficiency, particularly in hospitals, but who's bothered about that? Why tax your brains when you could just chop spending on preventive health programs, slash grants to the states and introduce a $7 co-payment for GP visits and tests?

The co-payment will shift costs to the states and add to ill health and costs down the track, but who's worried? It will be costly to administer, but less so when we advise ministers to whack it up again in a few years' time because health costs are still rising "unsustainably".

But the most mindless false economy is surely the now 2.5 per cent annual "efficiency dividend" cut imposed on the budgets of government departments. Treasury complains it's had to cut staff numbers by one-third just since 2011. Finance must be suffering, too.

Wouldn't it be ironic if the budget bureaucrats were among the chief victims of their failure to give the pollies better advice on spending control? By now, of course, this would be their chief excuse for continuing bad advice. "We don't have the resources, minister."
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Saturday, August 9, 2014

Teenagers suffering most from slow growth

I hate to say it, but the spectacular events that hit the headlines aren't necessarily the things most worth worrying about. The big news on the economy this week was the spectacular jump in the unemployment rate from 6 per cent to 6.4 per just during July. Not a big worry.

Question is, what does it prove? That the economy fell into a hole around the middle of the year? Doubt it. There's little other evidence that it did and a lot that it didn't.

That the slow upward creep in unemployment we've been seeing for about two years may have accelerated? Doubt that, too. Again, the other economic indicators aren't pointing that way.

(Indeed, some economists have been wondering if unemployment was close to peaking. So far this year employment has grown by an average of 15,600 jobs a month, compared with just 5100 a month last year.)

That the unemployment figures are volatile from month to month and this is an unexplained statistical blip that should be corrected next month? Seems a bit too big for that.

Truth is it's hard to know what the problem is. Easier to be sure when we've seen another month or two's figures.

But my guess is it's a once-only upward step in the measured rate of unemployment, caused by a seemingly small change in the questions that people in the Bureau of Statistics' monthly survey are asked so as to ascertain whether they've been "actively" seeking a job if they don't have one.

The change - made partly because of the switch to searching for jobs on the internet rather than at Centrelink - seems to have led to more people being classed as unemployed and fewer as "not in the labour force".

If this guess proves right, it's not so worrying. It doesn't change reality, just the way we measure it. In any case, we've long known that the official measure of unemployment is very narrow and understates the extent of the problem.

That's why the bureau publishes every quarter a broader measure of unemployment, which takes the official unemployment rate and adds the under-employed - people with jobs who aren't working as many hours a week as they'd like to - to give the "labour force underutilisation rate".

The figures for May show narrowly measured unemployment of 6 per cent, and an underemployment rate of 7.5 per cent, to give a broader measure of 13.5 per cent.

Less spectacular than this month's jump in the official rate but, to me, more worthy of worry is news that hasn't hit the headlines: the rapid worsening in teenage unemployment.

Whereas so far this year the trend rate of overall unemployment has risen by 0.2 percentage points, the trend rate for people aged 15 to 19 has risen by 2.8 percentage points to 19.3 per cent.

Note, this doesn't mean almost one youth in five is unemployed. Most people that age are in full-time education, so aren't in the calculation. Turns out about one in 20 of all 15 to 19 year-olds is unemployed and looking for a full-time job.

Many people have it in their heads that unemployment rises because people lose their jobs and employment falls. That's true only in recessions. It's rare for employment to fall - it fell only briefly even during the global financial crisis.

No, the main reason unemployment rises outside of recessions is that the economy isn't growing fast enough to employ all the extra people joining the labour force from education, as immigrants or as mothers rejoining.

That's what's been happening over the past two years. And young people - particularly those who leave school or training too early - have borne most of the burden of insufficient job creation. We should be doing much better by them than Work for the Dole and denying them benefits for six months to keep them hungry.

But there's nothing spectacular about this quiet suffering, so it doesn't hit the headlines. Much better to scandalise over factory closures, which surely signal the end of the world. So let's look at the facts on retrenchment, courtesy of a Bureau of Statistics study.

About 2 million people left their jobs over the year to February 2013 (the latest period for which figures are available). About 60 per cent of these left voluntarily and 21 per cent left because of their illness or injury, leaving 19 per cent - 380,000 - who left because they were retrenched.

That's a rate of retrenchment of 3.1 per cent. The rate hit 4 per cent in 2000, but then fell to a low of 2 per cent in 2008, just before the global financial crisis, then increased sharply to 3.1 per cent in 2010, where it has pretty much stayed since.

Over the year to 2013, all industries experienced retrenchments, but the most were in construction, 65,000; retailing, 40,000; and manufacturing, just under 40,000.

But the number of people employed in particular industries differs a lot so, judged by rate of retrenchment, utilities and construction come equal first with 6.4 per cent, then mining with 6 per cent, pushing manufacturing into fourth place with 4.5 per cent.

The rate of retrenchment is consistently higher for men because men tend to dominate those industries where retrenchment rates are higher, whereas retrenchment rates tend to be lower in industries dominated by women workers, such as education and health.

The likelihood of being retrenched falls as your level of educational attainment rises. We're more conscious of older workers being laid off but, in fact, retrenchment is greatest among workers aged 25 to 44.

And what happens to people who're laid off? For those retrenched over the year to February 2013, half were back in jobs by the end of the year, leaving 29 per cent unemployed and 21 per cent not in the labour force.
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Wednesday, August 6, 2014

Modellers bamboozle over cost of renewable energy

There's a lot of public support for the renewable energy target, which requires electricity retailers to get 20 per cent of their power from renewable sources by 2020. But now the country's being run by climate change "sceptics", let's get with the program. Forget the threat of climate change, stop worrying about your grandchildren and focus on what matters most: what this do-gooder scheme is doing to your cost of living.

Although before the election Tony Abbott professed support for the target, since the election he has instituted an expert review of it, headed by businessman Dick Warburton, former chairman of Caltex and prominent "sceptic".

The review commissioned a leading firm of economic consultants, ACIL Allen, to undertake modelling on the future effects of the target.

The preliminary report found that, between 2015 and 2020, the target would increase the average household electricity bill by $54 a year - a tad over $1 a week. This five-year average, however, conceals the estimation that the cost of the scheme will fall as each year passes.

So by 2020 itself, the increase will have reduced to just $7 a year. By the end of another 10 years, in 2030, the scheme is estimated to be actually reducing average household electricity bills by $91 a year, or $1.75 a week.

It's common sense that requiring electricity retailers to buy a certain proportion of their power from more expensive renewable sources - mainly wind power, but also solar - would add to the cost of their power, with the extra cost being passed on to consumers.

So why has ACIL Allen's modelling concluded the target will add to the price of electricity initially, but eventually subtract from it? The short answer is because electricity pricing is a complicated business.

It turns out that adding to the supply of renewable energy available reduces the wholesale price of electricity. This is because the price being paid for energy being put into the national electricity grid by particular generators varies minute by minute according to the balance of supply and demand.

In the middle of the night, when little power is being used, the wholesale price is very low. But on a cold evening - or, more likely these days, a very hot afternoon - the wholesale price can be stratospheric.

The trick to renewable energy is that it tends to be available when the demand for electricity is high. Experience around the world confirms the Australian experience that renewable energy does a great job of reducing spikes in wholesale prices on very hot and very cold days.

Another part of it is that though it costs a lot to build wind and solar generators, once they're built there are few "variable" costs. Wind and sun are free; coal and gas aren't. So the renewable generators offer to supply power to the grid at very low prices and this lowers the prices the coal and gas generators are able to ask for.

But none of this changes the fact that the electricity retailers have to pay for the "renewable energy certificates" that the target scheme requires them to buy. These certificates reduce the capital cost of setting up the wind and solar generators whose operations then reduce the wholesale cost of power.

So it turns out the renewable energy target scheme has the effect of reducing the wholesale cost of electricity while also adding to the costs of the electricity retailers. ACIL Allen's modelling suggests that, for the next five years, the extra retail cost will exceed the saving in wholesale costs, but after that the saving will exceed the extra cost.

See what this means? The case for saying we must get rid of the renewable energy scheme because it's adding too much to the living costs of struggling families has collapsed.

But there's where the story takes a twist. Modelling of the future cost of the renewable energy target, published by an equally prominent firm of economic consultants, Deloitte, comes to opposite conclusions.

Deloitte's modelling accepts that the renewable energy scheme is reducing wholesale costs, and roughly confirms ACIL Allen's finding about the higher cost to household customers until 2020. But whereas ACIL Allen expects the scheme to start reducing household costs after that, Deloitte expects the cost to stay positive until 2030, causing household bills to be between $47 and $65 a year higher than if the scheme was scrapped.

Why have two leading economic consultants reached such opposing conclusions? Perhaps because Deloitte's modelling was commissioned by the Chamber of Commerce and Industry, the Business Council and the Minerals Council.

Deloitte doesn't conceal that its modelling is in reply to ACIL Allen's. Would it surprise you if the fossil fuel industry wanted to see the renewable energy target abolished and was alarmed to know that modelling commissioned by the review had demolished the argument that continuing the target would add to people's electricity bills? Now the review will be able to pick whichever modelling results it prefers.

How did Deloitte reach such different results? By feeding different assumptions into its model. It seems to have assumed the cost of wind farms won't fall over time (which it probably will), whereas the price of gas for gas-fired generators won't rise much (which it already has).

Regrettably, economic modelling has degenerated into a device for bamboozling the public.
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Monday, August 4, 2014

Why no one is backing the budget

A big reason Joe Hockey isn't getting much support from independent observers like me in his battle to get the budget through the Senate is that so few of his contentious measures are worth fighting for.

If he were facing opposition from vested interests struggling to protect their privilege, or even just unthinking populism from the punters, it would be a different matter.

For a bit I thought I'd be in the trenches with him defending a plan to impose a temporary deficit levy on individuals with incomes above $80,000 a year but, as we now know, his boss insisted on lifting the threshold to a far-less-contentious $180,000 a year.

What would have made the lower threshold defensible is the inconvenient truth that so much of our present distance from budget surplus is explained by the folly of eight tax cuts in a row, the savings from which were skewed in favour of higher income-earners. This would have clawed back a bit of it.

It's remarkable anyone could put together a budget at once so unpopular and so lacking in Paul Keating's "quality cuts". Who did Hockey imagine would join him at the barricades apart from the mindlessly partisan commentators? (Even they haven't been particularly vociferous - although the government hasn't raised much of a banner to rally behind.)

In my initial assessment I said "I give Joe Hockey's first budgetary exam a distinction on management of the macro economy, a credit on micro-economic reform and a fail on fairness".

Nothing wrong with the F, and the D on macro management has stood up well. The decision to announce a lot of measures that didn't take much effect until the last year of the forward estimates, 2017-18, was a clever combination of macro-economic good sense - nothing to gain by hitting demand while it was expected to be weak - and political necessity.

By delaying the start of so many measures until after the next election Hockey was able to claim the budget didn't really break all the election promises Tony Abbott made when pushing his contention that a "budget emergency" could be fixed without pain.

It's not part of my religion to insist politicians keep irresponsible promises they should never have made. But that's not to say such blatant promise-breaking carries no political price. After all the fuss Abbott made about "Ju-liar" Gillard and his pretence about restoring trust in politicians, my guess is the price his government is paying is high. The pity is he could have won comfortably without such dishonesty.

On closer inspection, my C for micro reform was badly astray. Should have been an M for missed opportunity. There was a lot of cost shifting, but precious little that could be claimed to increase the efficiency with which the government delivers its many high-cost services or to reduce rent-seeking by private industries.

The greatest disappointment was that, after making a good start in eliminating handouts to the car makers and refusing to bail out fruit canners, Hockey dropped the ball on business welfare, thus leaving all his talk of ending "the age of entitlement" looking like nothing more than a shameful attack on the poor and disadvantaged.

One honourable exception was the decision to remove the always-indefensible subsidy to locally produced ethanol. Another was the plan to resume indexing the fuel excise.

Removing the carbon price involved allowing fossil-fuel industries to continue imposing external costs on the rest of the community and the intention to abolish the mining tax involves allowing much receipt of economic rent by foreigners to go grossly under-taxed. That's efficient?

Add to that the failure to remove the fuel excise credit, which constitutes a favour to miners and farmers but no one else, and you have to ask what hold the big three mining companies have over this government.

Similarly, take the cutting back on the age pension while doing nothing whatsoever to curb the excesses of the concessional tax treatment of superannuation, combine it with watering down the Future of Financial Advice Act despite the presence of gross information asymmetry, and you have to ask what hold the big four banks have over this government.

On its face, you could have expected the "deregulation" of university fees to bring significant gains in efficiency - but only if your understanding of economics had progressed no further than 101. To take a relatively small number of government-owned and still highly regulated agencies with a monopoly over credential-granting, allow them to set their own fees and then imagine an adequately competitive "market" would emerge isn't economics, it's magical thinking.
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Saturday, August 2, 2014

Chinese economy overtaking US and getting more like it

It isn't so many years since I used to berate the denizens of the financial markets for their lack of interest in the economy that had so much influence on ours: China. How things have changed. So has China.

After averaging growth of 10 per cent a year for 30 years, China's economy is now struggling to achieve its reduced target of 7.5 per cent. The financial market participants' role has been to watch on with concern.

And this week comes news that, though the International Monetary Fund sees China coming close to target this year, it expects it to slow to 7.1 per cent growth in 2015 and slow further in following years.

More surprisingly, the fund says that China should slow down to give it a chance to work on its big problems, rapidly growing debt and a rapidly contracting real estate market. Fumble those and growth could be even lower.

But while so many of us have been so focused on China's difficulty maintaining its rate of growth, we've lost sight of how big it is and how fast it's still growing compared with the rest of us.

Compared, say, with the world's biggest economy, the United States. Except that, according to the calculations of Euromonitor International, China will overtake the US this year. That's when you compare the two economies using "purchasing-power parity", which makes allowance for the fact that one US dollar buys a lot more in China than it does in the land of the free.

With China biggest and the US second, then come India, Japan, Germany, Russia and Brazil. We come in at 17th, not far behind Indonesia. The world certainly is changing.

Of course, the Chinese and American economies remain very different. China is big because of its much bigger population - 1.4 billion versus 300 million. Its income per person remains a fraction of America's. A not unrelated fact is that the US's productivity (measured as gross domestic product per worker) is more than nine times higher than China's.

And the two countries' industry structure is also very different. Agriculture contributes 10 per cent to GDP in China but just 1 per cent in the US. But get this: it accounts for almost a third of the workforce, compared with just 1.4 per cent in the US.

Manufacturing makes up 30 per cent of China's GDP, but only 13 per cent of America's. That tells us a lot about why China's rise, and the growth in its exports of manufactures, has affected so many other countries as well as maintaining downward pressure on world prices.

But the biggest difference between the two economies is their relative emphases on consumption and investment. Euromonitor International estimates that this year private consumption will account for 68 per cent of GDP in the US, compared with 37 per cent in China.

Here, however, we get to the really important news: the Chinese authorities have embarked on a process of "rebalancing" the economy, increasing consumer spending and domestic demand and reducing the roles of exports and investment in heavy industry.

The Economist notes that consumer spending has already begun its expansion, with its share of GDP rising from less than 35 per cent in 2010 to more than 36 per cent last year. And this year it has accounted for more than half the growth in GDP.

A big reason for stronger consumer spending is rapid growth in wages. Get this one: over the five years to 2013, real wages in manufacturing rose by about 2 per cent in the US, but by 45 per cent in China. As always happens, the benefits of economic development do flow eventually to ordinary workers.

This strong growth in consumption involves faster growth in the services sector, with manufacturing's share of GDP having peaked at almost a third in 2007.

This structural change means people following the ups and downs of the Chinese economy ought to be following a different set of indicators, as Peter Cai of China Spectator noted last week with help from Guan Qingyou, an economist at Minsheng Securities.

Cai says the main reason Chinese policymakers care so much about the rate of growth in GDP is their belief that the economy needs to grow by at least 7.2 per cent to absorb 10 million new entrants to the labour market each year.

But this correlation has been breaking down since 2010. Slower growth in GDP has not led to weaker job creation. Gaun suggests this is because the expanding services sector has a greater capacity to absorb new job seekers.


More fundamentally, China seems to be approaching its "Lewis turning-point", where a developing country runs out of its supply of surplus rural labour. This would also help explain the rising real wages.

Financial market participants focus on the growth in "industrial production" (manufacturing, mining and utilities) as a predictor of GDP growth, and on the manufacturing PMI (purchasing managers' index) as a predictor of industrial production.

But Cai says the strong correlation between industrial production and GDP is breaking down because the services sector is growing a lot faster than the industrial sector. Last year, for instance, the services sector contributed 47 per cent of the annual growth in GDP, whereas the industrial sector contributed less than 40 per cent. So, it's better to focus on the services sector PMI.

A big problem for China-watchers is that you don't know how much faith to put in official statistics. Earlier in his career, Premier Li Keqiang let it be known that he, too, had his doubts. So he focused on railway freight volumes, electricity consumption and bank lending as offering a better guide.

Now others have developed a "Li Keqiang index". But here, too, Guan argues that its reliability has declined, because of changes in the structure of industrial electricity use and changes in financing. China is changing.
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Wednesday, July 30, 2014

Social and economic case for helping women work

Surely the most momentous social change of our times began sometime in the 1960s or '70s when parents decided their daughters were just as entitled to an education as their sons. Girls embraced this opportunity with such diligence that today they leave schools and universities better educated than boys.

Fine. But this has required much change to social and economic institutions, which we've found quite painful and is far from complete. It's changed the way marriages and families operate - changed even the demands made on grandparents - greatly increased public and private spending on education, led to the rise of new classes of education and childcare, changed professions and changed the workplace.

It has led to greater "assortative mating", where people are more likely to marry those not just of similar social background, but of a similar level of education.

For centuries the labour market was built around the needs of men. Changing it to accommodate the needs of the child-bearing sex has met much resistance, and we have a lot further to go. This is evident from last week's report of the Human Rights Commission, which found much evidence to show "discrimination towards pregnant employees and working parents remains a widespread and systemic issue which inhibits the full and equal participation of working parents, and in particular, women, in the labour force".

You can see this from a largely social perspective - accommodating the rising aspirations of women and ensuring they get equal treatment - or, as is the custom in this more materialist age, you can see it from an economic perspective.

By now we - the taxpayer, parents and the young women themselves - have made a hugely expensive investment in the education of women. It accounts for a little over half our annual investment in education.

If we fail to make it reasonably easy for women to use their education in the paid workforce, we'll waste a lot of that money. Our neglect will cause us to be a lot less prosperous than we could be.

Of late, economists are worried our material standard of living will rise more slowly than we're used to, partly because mineral export prices have fallen but also because, with the ageing of the baby boomers, a smaller proportion of the population will be working.

They see increased female participation in the labour force - more women with paid work, more working women with full-time jobs - as a big part of the answer to this looming catastrophe (not).

But how? One way would be to impose more requirements on employers, but in an era where the interests of business are paramount, politicians are reluctant to do that. Make employers provide childcare or paid parental leave? Unthinkable.

So, for the most part, taxpayers have picked up the tab. Government funding of childcare has reached about $7 billion a year, covering almost two-thirds of the total cost. The cost of government-provided paid parental leave is on top of that.

Governments' goals in childcare have evolved over time. In the '70s and '80s, the focus was on increasing the number of places provided. In the '90s, the focus shifted to improving the affordability of care, with the introduction of, first, the means-tested childcare benefit, and then the unmeans-tested childcare rebate. Under the Howard government, the rebate covered 30 per cent of net cost, but Labor increased it to 50 per cent.

More recently, increased evidence of the impact of the early years of a child's life on their future wellbeing has shifted governments' objectives towards child development and higher-quality, more educationally informed, childcare. This includes getting all children to attend pre-school. Linked with this has been a push to raise the pay of childcare workers.

The federal government asked the Productivity Commission to inquire into childcare and early childhood learning. Last week it produced a draft report. I suspect the pollies were hoping the commission would find a way to reduce regulation of what they kept calling the childcare "market"; thus improving workforce participation and "flexibility" while achieving "fiscal sustainability".

If so, they wouldn't have been pleased with the results. The main proposal was that the childcare benefit and rebate be combined into one, means-tested subsidy payment paid direct to childcare providers.

This would involve low-income families getting more help while high-income families get less. There would be a small additional cost to the government, but this could be covered by diverting money from Tony Abbott's proposed changes to paid parental leave. It was "unclear" his changes would bring significant additional benefits to the community.

The commission wasn't able to claim its proposals would do much to raise participation in the labour force, mainly because our system of means-testing benefits - which works well in keeping taxes low, something that seems to be this government's overriding goal - means women face almost prohibitively high effective tax rates as their incomes rise, particularly moving from part-time to full-time jobs.

Like the Henry tax review before it, the commission just threw up its hands at this problem. And even the commission couldn't bring itself to propose major reductions in the quality of education and care. Sorry, no easy answers on childcare.
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Monday, July 28, 2014

A more balanced budget might get through Senate

Joe Hockey and Tony Abbott are perfectly right in saying we need to get the budget back into surplus, we need to make a start now and that this will inevitably involve unpopular measures.

But this makes it all the more puzzling that, lacking a majority in the Senate and being unable to claim a "mandate" for breaking many election promises, they should adopt such a highly ideological and unfair collection of budget measures.

In a three-part essay on John Menadue's blog last week, Dr Michael Keating, former senior econocrat, argues that as a nation we're "unlikely to succeed in charting a viable way forward to fiscal sustainability until governments are prepared to subject their views to a proper conversation based on a clear appreciation of the pros and cons of the different alternatives.

"Only in that way can the public support be built that is required to achieve future fiscal sustainability. In present circumstances it is hardly surprising that this necessary support is not forthcoming, when less than 12 months ago the government promised in the election to both spend more and tax less and now seeks to impose a most unfair budget on the community with no prior warning nor any such mandate."

If we are to chart a way forward and establish the necessary public understanding and consensus, he says, we particularly need to drop the ideology surrounding the merits of taxation versus expenditure and consider the claims of each tax and expenditure proposal on its merits.

Just so. There are many ways to skin the budget cat - some fairer or more sensible than others - and it's absurd for the government and its barrackers to pretend, Maggie Thatcher-like, that the measures proposed in the budget are the only alternative to irresponsible populism.

Anyone who knows anything about successful "fiscal consolidation" knows it invariably involves a combination of spending cuts and tax increases (including reductions in tax concessions - "tax expenditures").

And anyone who knows much about economics knows there's little empirical evidence to support the ideology that economies with high levels of government spending and taxation don't perform as well as those with low levels.

Yet Hockey and Abbott thought it sensible to propose a 10-year budget plan that relied almost exclusively on cuts in government spending - apart from the temporary deficit levy and much unacknowledged bracket creep.

Keating points out that, combining all levels of government as a percentage of gross domestic product, Australia already has the lowest budget deficit and public debt compared with Canada, Japan, Britain, the US and the OECD average.

At 26.5 per cent, our level of total taxation seems higher than the Americans' 24 per cent, until you remember their budget deficit is 5 percentage points higher than ours. So the claim that we have a bloated, "unsustainable" level of government spending is itself unsustainable.

To restore some balance to proposed budget savings, to share the burden of budget repair more fairly and in answer to the challenge, well, what would you do? Keating suggests savings on the revenue side that would raise about $42 billion a year in 2017-18, the year most of Hockey's savings would cut in.

One objectionable feature of the budget was the way it laid into spending on the age pension while not merely ignoring the equally expensive superannuation tax concessions but actually reversing some of Labor's timid attempt to make aged-income support fairer. Keating estimates a more balanced approach to tax concessions could save $15.5 billion a year.

To extend the "end of entitlement" beyond welfare recipients to business welfare, he suggests ending the fuel excise rebate for miners and farmers, saving $7.5 billion a year. There's no economic justification for subsidising just one input among many of just two industries among many.

Abolishing the subsidy for private health insurance would save more than $7 billion a year. Many evaluations have shown this money would treat a greater number of patients if spent in public hospitals. Removing the 50 per cent discount on capital gains tax would save $5 billion a year, as well as making the taxation of various sources of income a lot fairer.

About $5.5 billion a year could be saved by restoring the carbon price mechanism and the minerals resource rent tax. That leaves $1.5 billion to be saved by restoring anti-avoidance measures implemented by Labor, Keating says.

We could get the budget back in the black without any loss of economic efficiency and do it in a way much fairer to ordinary voters - remember them? - and less partial to the Coalition's big business backers.
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Saturday, July 26, 2014

Why we're still not free of the GFC

Almost six years since the global financial crisis reached its height, it's easy to forget just how close to the brink the world economy came. To someone like Reserve Bank governor Glenn Stevens, however, those events are burnt on his brain.

Which explains why he thought them worth recalling in a speech this week. And also why, so many years later, the major developed economies of the North Atlantic are still so weak and showing little sign of returning to normal growth any time soon.

When those key decision-makers who lived through 2008 and 2009 say that there was the potential for an outcome every bit as disastrous as the Great Depression of the 1930s, "I don't think that is an exaggeration", he says.

"Any account of the events of September and October 2008 reminds one of what an extraordinary couple of months they were. Virtually every day would bring news of major financial institutions in distress, markets gyrating wildly or closing altogether, rapid international spillovers and public interventions on an unprecedented scale in an attempt to stabilise the situation.

"It was a global panic. The accounts of some of the key decision-makers that have been published give even more sense of how desperately close to the edge they thought the system came and how difficult the task was of stopping it going over."

But, despite the inevitable "mistakes and misjudgments", the authorities did stop it going over. Stevens attributes this to their having learnt the lessons of the monumental mistakes and misjudgments that that turned the Great (sharemarket) Crash of 1929 into the Great Depression.

Economic historians (including one Ben Bernanke) spent decades studying the Depression and, in Stevens' summation, they came up with five key lessons: be prepared to add liquidity – if necessary, a lot of it – to financial systems that are under stress; don't let bank failures and a massive credit crunch reinforce a contraction in economic activity that is already occurring – try to break that feedback loop; be prepared to use macro-economic policy aggressively.

So far as possible, maintain dialogue and co-operation between countries and keep markets open, meaning don't resort to trade protectionism or "beggar-thy-neighbour" exchange rate policies. And act in ways that promote confidence – have a plan.

There was a lot of action and a lot of international co-operation, and it worked. As a result, we talk about the Great Recession, not the Great Depression Mark II.

"We may not like the politics or the optics of it all – all the 'bailouts', the sense that some people who behaved irresponsibly got away with it, the recriminations, the second-guessing after the event and so on," he says. "But the alternative was worse."

With collapse averted, the next step was to fix the broken banks. Their bad debts had to be written off and their share capital replenished, either by them raising capital from the markets or accepting it from the government.

Fixing the banks' balance sheets was necessary for recovery, but not sufficient. A sound financial system isn't the initiating force for growth, so stimulatory macro-economic policies were needed to get things moving.

On top of all the government spending to recapitalise the banks came a huge amount fiscal (budgetary) stimulus spending. Stevens says a financial crisis and a deep recession can easily add 20 or 30 percentage points to the ratio of public debt to gross domestic product.

Then you've got the weak economic growth leading to far weaker than normal levels of tax collections. Add to all that the various North Atlantic economies that had been running annual budget deficits for years before the crisis happened.

"So fiscal policy has not had as much scope to continue supporting recovery as might have been hoped," Stevens says. "Policymakers in some instances have felt they had little choice but to move into consolidation mode [spending cuts and tax increases] early in the recovery."

He doesn't say, but I will: this crazy, counterproductive policy of "austerity" has helped to prolong the agony.

With fiscal policy judged to have used up its scope for stimulus, that leaves monetary policy. Central banks cut short-term interest rates hard, but were prevented from doing more because they soon hit the "zero lower bound" (you can't go lower than 0 per cent).

But long-term interest rates were still well above zero and, in the US and the euro area, long-term rates play a more central role in the economy than they do in Oz. Hence the resort to "quantitative easing".

Under QE, the central bank buys long-term government bonds or even private bonds and pays for them merely by crediting the accounts of the banks it bought from. Adding to the demand for bonds forces their price up and yield (interest rate) down. And reducing long-term rates is intended to stimulate borrowing and spending.

Has it worked? It's intended to encourage risk-taking, but are these risks taken by genuine entrepreneurs producing in the real economy, or are they financial risk-taking through such devices as increased leverage?

Stevens' judgment is that it always takes time for an economy to heal after a financial crisis [because it takes so long for banks, businesses and households to get their balance sheets back in order - they've borrowed heavily to buy assets now worth much less than they paid] so it's too soon to draw strong conclusions.

For Stevens, the lesson is that there are limits to how much monetary policy can do to get economies back to healthy growth after financial crises. "If people simply don't wish to take on new business risks, monetary policy can't make them," he says.

Perhaps the answer is simply subdued "animal spirits" – low levels of confidence, he thinks. But, at some stage, sharemarket analysts and the investor community will ask fewer questions about risk reduction and more about the company's growth strategy.

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