Monday, August 30, 2010

Why political rivalry reduces voters' options

Simple economic theory tells us competition leads to increased choice. But as the election campaign showed, competition between the two main parties seems to be reducing the choice we're offered.

Before the election, many people complained about how unengaging the campaign was. It didn't seem to be aimed at people with brains. It seemed dominated by trivia. The two sides were locked in furious argument, but the policy differences between them seemed minor.

We were offered no real choice on climate change, industrial relations, the harsh treatment of boat people, the war in Afghanistan or economic management (the choice between a budget surplus in 2012-13 of $3.5 billion or $6.2 billion).

The main issues of genuine choice were the mining tax and the national broadband network. And even these didn't get a lot of attention. I'd like to believe the electorate's failure to decide which of the parties it wanted and its tendency to turn to minor parties and independents was a reaction to the unattractive choices we faced. Let's hope the pollies learn never to stage such an empty campaign again.

I don't deny the media's part in the campaign's superficiality. Every available diversion from serious discussion of policy choices was seized on. There was more "race calling" - Who won the leaders' debate? Which side won the week's campaigning? Who do the polls say is winning? - as politics was turned into a spectator sport rather than an earnest evaluation of policies.

One lesson from behavioural economics is that when consumers face excessive, confusing choice they tend to avoid making a decision. In this case, however, it seems it was lack of choice that caused voters to be so indecisive.

Most economists believe choice is a virtue in itself (true) and the more choice the better (above a certain point, not true). They love competition because their simple neo-classical model of markets predicts competition leads to wider choice.

So how come competition between political parties seems to be reducing choice? The simple market model rests on the assumption of "atomistic" competition: a large number of small sellers, none big enough to be able to influence the price, with each needing to give customers exactly what they want or be forced out of business.

In the modern world, few, if any, markets work that way. Much of our increased prosperity is owed to firms' pursuit of economies of scale. But this has created a tendency for firms to get much bigger and for many markets to be dominated by a small number of large firms.

Hence the real-world prevalence of "oligopoly". Clearly, under oligopoly - and duopoly, a form of it particularly common in Australia - there's only a small number of sellers and thus less choice, although each firm is likely to offer a full product range.

Under oligopoly, firms compete for market share, with increased share of the market being the main way they seek to maximise profits. But because each firm has a fairly big share of the market, each has the ability to influence the market price and thus affect the fortunes of the others.

This means competition in oligopolised markets takes on a form unknown in the basic market model: rivalry. Firms focus on each other and never make a move without first considering how their rivals may react to that move.

Here we're getting closer to competition in the political "market". Most people imagine governments, holding the reins of power, concentrate on deciding what to do and whether the voting customers are likely to react well or badly.

It's always a surprise to people to realise how much the behaviour (or expected behaviour) of oppositions influences the behaviour of governments. You and I may regard oppositions as largely irrelevant until the next election, but governments never do. That's rivalry.

Hugh Mackay says the key to competition is to focus on the customers and their needs, not your competitors and what they're doing. I think he's right, but it's tough advice to follow in an oligopolistic market.

The same goes for politicians. In their case, I think rivalry - obsession with your competitors - and the fear of taking a misstep help explain why both sides converge on the centre and adopt similar policies.

The market analogy takes us only so far. In a duopoly the two rivals share the market and fight for greater market share only at the margin. Politics, by contrast, is a winner-takes-all market. Lose the election and you get a zero market share.

Perhaps this all-or-nothing feature of political competition tends to make the parties more risk averse. Maybe it's the case that, just as oligopolists prefer to avoid competing on price, so the major political parties prefer to avoid competing on policy. In this campaign, both sides wanted to battle over perceptions of competence rather than my policy versus yours.

But this doesn't explain why the aversion to policy choice is relatively recent, why we now live in post-ideological times. I suspect the reason is the advent of what I call "scientific" politics, the rise of backroom specialists who use polling, focus groups and other market research techniques to peer into the minds of voters, particularly those judged to be swinging voters in marginal seats.

Knowing so clearly the likes and dislikes of key voters - chosen explicitly for their lack of ideological commitment - probably drives the major parties towards common ground, encourages pragmatism over idealism and prompts them to offer bribes rather than reforms.

Let's hope the hung parliament causes them to reconsider this form of scientific "progress".


Saturday, August 28, 2010

Numbers say we're growing quite nicely

The mildness of last year's recession means the economy has now entered its 20th year of growth since the deep recession of the early 1990s. But how has this growth been distributed through the economy? That's a question Ric Battellino, the deputy governor of the Reserve Bank, set out to answer in a most informative speech last week.

It's a question you can answer in different ways. For a start, since June 1991, 3.5 million additional jobs have been created, representing an average increase of 2 per cent a year. Income per household has risen in total by 30 per cent in real terms.

But this means employment grew faster than the population. How was this possible? Because there was a rise in the proportion of the population choosing to participate in the workforce and also because of a fall in the rate of unemployment from 9 per cent to a little over 5 per cent.

When you divide the growth between the states, however, it was quite uneven. Over the 18 years to 2008-09, Queensland grew at an average rate of 4.8 per cent a year, followed by Western Australia on 4.5 per cent. Victoria came third on 3.7 per cent. At the rear came South Australia, Tasmania and NSW on about 2.9 per cent.

But much of this faster economic growth came because of faster population growth. Queensland's population grew at the rate of 2.2 per cent a year, followed by Western Australia on 1.8 per cent, Victoria (1.2 per cent), NSW (1 per cent), South Australia (0.6 per cent) and Tasmania (0.4 per cent).

So it turns out when you look at growth per person - that is, at the growth in material living standards - much of the disparity disappears. Western Australia's average growth in real income per person of 2.7 per cent was just a fraction faster than Queensland's (2.6 per cent) and Victoria and Tasmania's (both 2.5 per cent). Then came South Australia on 2.3 per cent and NSW on 1.8 per cent.

Thus a 2 percentage point disparity in income growth between the fastest and slowest states was reduced to less than a 1 percentage point disparity after allowing for population growth.

Similarly, the disparity in unemployment rates isn't all that great, with most states ending up on 5.6 per cent, but with Tasmania on 6.5 per cent and WA on 4.4 per cent.

Another question is how the increased income over the period was distributed between households of different income levels. If you imagine it's got a lot more unequal, then you've been reading too many newspapers.

"Income relativities across the bulk of the population did not change much over the period, though the relative position of households in the top 10 per cent of the income distribution improved somewhat, and that of households in the lowest 10 per cent deteriorated," Battellino said.

One area where there has been sizeable differences in growth performance is between industries.

Over the 17 years to June 2009, Australia's total output grew at an average rate of 3.6 per cent a year and each of the 14 industry categories recorded positive growth in their output. But some grew faster than the national average and some grew more slowly than it.

Those growing at rates well above the average included financial services, professional and technical services, and construction. Those growing at rates well below the average included agriculture and manufacturing.

Now we've covered the differing growth rates, we can look at how the structure of industry has changed - that is, at industries' changing shares of the economy.

The financial services sector's share of total output (gross domestic product) has grown by a remarkable 3.8 percentage points to 10.8 per cent, making it now our biggest industry.

The financial sector has long grown faster than the rest of the economy in all the developed countries because we've been borrowing and lending more, saving more for retirement through pension funds (in Australia, because 9 per cent of wages is going into super funds) and doing more to manage risks by use of derivatives.

Just how sensibly based all this financial activity has been we may now question, following the global financial crisis and its revelations. It might not be a bad thing for the financial sector to grow at a slower rate than the rest of the economy in coming years.

The mining sector's share of GDP has grown by 2.7 percentage points to 7.7 per cent, probably the biggest it's been since the gold rush and bigger than any other developed country can claim.

Even so, that's probably not as big as many people have imagined from all the fuss about the resources boom. But with the growth of mining has gone the rise in the construction sector's share of GDP, by 1.1 percentage points to 7.4 per cent.

You may imagine that, to the extent it comes from the building of new mines and natural gas facilities, this increase in construction will be temporary. Not that temporary. The miners have plans to keep constructing new facilities for the rest of the decade at least.

Leaving aside China's continuing demand for our resources, if India keeps growing at the rates it has been over the past decade it will need huge quantities of iron ore, and much of that will come from Australia.

The growth in mine building probably also does much to explain the rise in the share of the "professional, scientific and technical services" sector by 1.8 percentage points to 6.1 per cent.

But if some industries' shares of the economy are getting bigger, others' shares must be getting smaller. The two stand-out cases are agriculture (down 0.7 percentage points to a mere 2.6 per cent of GDP) and manufacturing (down 4.6 percentage points to 9.4 per cent). So the past 17 years have seen manufacturing decline from our largest industry to our fourth largest (after financial services, education and health, and retail and wholesale). Remember, both agriculture and manufacturing are producing a lot more than they did in the early '90s; it's just that other sectors have grown faster.

Many people lament manufacturing's declining importance in our economy (and every other developed economy) as economies become more services-intensive and less goods-intensive and as the global growth in manufacturing shifts to the developing world. But as Battellino observes, manufacturing's small share of our economy has been one reason we fared so well over the past couple of decades (not to mention in the global financial crisis).


Wednesday, August 25, 2010

Revolution of thinking voter turns politics green

Sorry but I'm not convinced a hung parliament is a terrible thing. It may end up being a good thing. I see it as the revolt of thinking voters against an election campaign that was aimed almost exclusively at unthinking voters.

Labor's been given an almighty kick in the pants but there was no enthusiastic embrace of the Liberals, whose campaign was almost completely negative. The parties should take it as a warning that if they want to win sufficient votes to form government in their own right next time, they should offer more sensible policies and arguments.

The big winner is the emerging third party, the Greens. Labor's share of the primary vote fell by almost 5 percentage points but the Coalition's share rose by only about 1.4 percentage points, with the Greens' share up by 3.6 points.

Those figures make it seem as though all the Greens' additional votes came from Labor. In truth, they show only the Coalition's net gain in votes, concealing those votes it too lost to the Greens. Had the optional preferential voting system been available, I'm sure many of those who voted for the Greens wouldn't have allowed their preferences to flow back to either party.

The swing to the Greens was even greater in the Senate, where their primary vote of almost 13 per cent is expected to give them an extra senator in each state, with some of those positions taken from the Libs. This will lift the Greens' total senators to nine, giving them the balance of power in the Senate from July next year and probably for at least the next six years.

So unattractive was the choice the main parties offered that I'm sure people voted Greens for various reasons. But no doubt concern about lack of "real action" on climate change was the most prominent. Consider the way people concerned about global warming - still a majority of voters - were dudded by the two main parties. Both went to the last election promising to introduce (similar) emissions trading schemes; both went to this election promising not to introduce such schemes.

As Dr Richard Denniss of the Australia Institute observes in a paper to be released today, this election has shown just how much of a challenge new issues such as climate change are for old political structures. Despite much of the election allegedly being fought on economic management, neither Labor nor the Libs had to explain how they could claim to be "good economic managers" yet they were determined to ignore all economic evidence about the best way to tackle climate change.

The Libs describe their approach as "direct action" - which translates as support for the regulation and government intervention once primarily associated with Labor. Labor's major contribution to the climate change policy debate during the campaign was its proposal for a "citizens' assembly", which sounds reminiscent of the Greens' historical preference for "consensus-based" decision-making. "The Greens, on the other hand, have been pushing for the economic rationalist approach of relying on a carbon tax and price signals," Denniss says.

Despite the Liberals' pious condemnation of waste in the campaign, most of their direct action policies would be riddled with waste, with the likely cost per tonne of emissions reduced by their subsidy schemes far exceeding any price per tonne contemplated under emissions trading or a carbon tax. The same is true of Labor's proposed cash-for-clunkers scheme.

The parties' failure to gain a majority in their own right means neither can claim a Mandate for the policies they took to the election. The side that finally reaches a deal with the independents will probably have had to change its policies to achieve that deal.

But this sudden need for policy flexibility in response to unexpected circumstances could be good news for those silly sausages who worry about saving the planet. By my reckoning, three of the four members expected to hold the balance of power in the lower house - the three country independents and the Greens MP for Melbourne - accept the need for a price on carbon. And then, of course, there's the Greens' balance of power in the Senate.

There's no substitute for a government with a logically consistent set of policies (and no reason only one major party should have a monopoly on the desire to save the economy from the ravages of climate change). But for the benefit of those independents - or anyone else - seeking a coherent approach to the problem, the Australia Institute's paper, Once More With Feeling, sets out six principles for good policy design.

First, remove subsidies that encourage the use of greenhouse gas-emitting fuels. These include the concessional taxation of company cars and (controversially for the country independents) the fuel tax credit scheme.

Second, introduce a price on greenhouse gas emissions. Given the rejection and abandonment of Labor's carbon pollution reduction scheme, a simple carbon tax - as already proposed by the Greens - may be the best starting place.

Third, remove existing subsidies to renewable energy that don't deliver low cost of abatement or help develop a domestic industry. For instance, the present subsidy for photovoltaic solar panels on rooftops has been found to cost $447 per tonne of emissions avoided. As for developing a local industry, the panels are imported.

Fourth, invest in public transport and other infrastructure to ensure consumers can more easily respond to the higher price of fossil fuels.

Fifth, regulate to enhance energy efficiency where existing market failures reduce the ability of higher energy prices to achieve reduced energy consumption.

And finally, provide business investors with certainty about the direction, if not the destination, of legislative change.

Two-party government has reached a sad state when neither side is offering such a sensible - dare I say, rational - approach to our greatest and most pressing economic threat.


Monday, August 23, 2010

Voters censure Labor's lack of principles

The one thing we can be sure of is Labor has suffered a huge reverse. While we wait to learn which party will form government, it's instructive to ponder what it did wrong.

By all the rules of federal politics, Labor should have romped home. The rules say first-term governments get an extension to finish proving their worth. They say governments get tossed out after they've allowed the economy to bomb, not after they've seemingly avoided a recession. They also say voters distinguish between federal and state. But one rule has stood up: oppositions don't win elections, governments lose them. This disaster for Labor is its own fault.

Labor has been a remarkably timid government. Saturday's failure could make it even more so, but that would be fatal. Similarly, the conclusion Labor's reversal was caused just by a bad election campaign would be delusional.

No, if Labor wants to learn from its drubbing it needs to draw the obvious lesson: voters punished it for its lack of principles. Those who still voted for it did so with no enthusiasm and many registered their protest by turning to the Greens.

The great paradox of politics is that though voters hate change and hip-pocket pain, they want to be led by people with convictions and the courage of them. First Kevin Rudd and then Julia Gillard were too conscious of the former and oblivious to the latter.

Every politician wants to be re-elected, but good politicians don't want just to preside over the economy and keep it on track, they also want to reform it. They understand the hard part of politics is getting re-elected and making reforms. When the going got tough, Rudd threw overboard the economic reform that, along with rolling back the Work Choices false reform, had been at the centre of his case for election: introduction of an emissions trading scheme.

The end of Rudd's remarkably long honeymoon with the electorate can be dated to his decision to give up on climate change rather than fight for its approval by a joint sitting following a double dissolution.

Even those relieved to be free of a "great, big, new tax" were shocked by such a cowardly repudiation of one of Labor's core values. Sensing this, the Liberals immediately switch from criticising the scheme to criticising Labor's abandonment of its "greatest moral challenge". With this act Labor sent the electorate a signal: we're not moral.

When Gillard deposed Rudd and set about getting the government back on track she had an opportunity to redeem the position to some extent, but again Labor's lack of conviction let it down. She toyed with taking tentative steps towards a carbon price, but in the end decided on a gimmick the public instantly saw through: the 150-person citizens assembly. The end of Gillard's own brief honeymoon can be dated to that gutless decision.

Voters work on instincts and impressions, not rational analysis. They can smell a politician who puts self-preservation ahead of the national interest. They can smell it even when they're not sure they fancy the measures need to advance the national interest. And they're never impressed. But Labor's loss of principles extends beyond its loss of core belief in the need for reform. It also involves standards of acceptable behaviour in public life. It's now clear many voters were repelled by Labor's ruthless treatment of Rudd, and by Gillard's part in it despite all her protestations of loyalty.

No policy reform principles and no personal principles turned out to be a deadly combination. Gillard stands revealed as little more than a careerist. Such people never endear themselves to the electorate.

Labor should dispense with the unprincipled Sussex Street thugs who were behind-the-scenes urgers on every major false step it made in its first term. It was they who (acting behind Gillard and Wayne Swan) persuaded Rudd to abandon his climate-change commitment, they who staged his beheading in a way that offended so many Labor supporters and they who advised Gillard to rush to an election while her honeymoon lasted, when she should have allowed more dust to settle and given voters more time to get to know her.

These are the same geniuses who've brought us the debacle of the Carr-Iemma-Rees-Keneally government (which itself contributed to Gillard's drubbing). They're uncomprehending bunglers of the first order. They're so ruthless and cynical they've lost consciousness of the electorate's basic decency.

They're all expediency and no values, all tactics and no strategy. But with all their pragmatism and tricky tactics, they can't deliver the goods.

Labor must abandon its obsession with controlling the 24-hour news cycle. The spin doctors kept Rudd in control of the news for the best part of three years, but where did that get Labor in the end? This preoccupation with control and an unending stream of trivial "announceables" distracts ministers and their departments from real work. The excessive control antagonises the press gallery, which waits its chance to strike back when you're vulnerable (as Rudd discovered as soon as his ratings slipped).

Apparatchik Labor's lack of convictions saps it of the will to fight for needed but controversial reforms; the 24-hour spin doctors' dark arts sap it of the ability to fight. It's a snare and a delusion. Senior ministers get so used to relying on media stunts and emotional button-pushing their ability to explain and defend complicated policies atrophies.

That Labor ended up on the defensive over its enviable economic performance shows how badly it was served by its media minders. Their stock in trade is always to change the subject, never to stand and fight; to bamboozle, never to educate.

Labor's Hollow Men period has brought it disaster. Time to recover some values.


Sunday, August 22, 2010

The deficit we really should worry about

The biggest and most worrying deficit in this election campaign has been the policy deficit: the reluctance of both sides to debate any aspect of economic management bar the budget.

What has passed for economic debate has proceeded from the proposition that the federal budget equals the economy. So let's see if we can get through a discussion of our economic policy challenges without further mention of that instrument.

The most obvious disappointment about this campaign is both sides are pledging to do nothing serious in the coming three years about the greatest and most pressing threat to the economy: climate change.

Left unchecked, climate change is likely to destroy or significantly damage much of our stock of private and public physical capital. To avoid the small cost of growth forgone as we tackle the problem, we're willing to risk incurring much greater losses.

Because of both sides' unwillingness to impose on voters unpleasantness roughly akin to the introduction of the goods and services tax, they're willing to waste taxpayers' money on ineffective incentive schemes while also causing the cost of eventual action to be higher than it need be. (That's assuming we wake up before we reach the point where the damage has become irreversible.)

At a more conventional level, the glaring need neither side seems to have noticed, much less wanted to do anything about, is what could be called our productivity deficit: after perking up mightily in the 1990s, our rate of productivity improvement - measured as output per hour of labour - slumped throughout the noughties.

What should we be doing to lift our productivity performance? That's what we should have been debating over the past five weeks. Failing that, it's a question we should be setting our minds to during the coming parliamentary term.

One reason we haven't had more soul-searching over the productivity deficit is that its adverse effect on our rate of economic growth - and continually rising material living standard - has been offset by the resources boom.

National income has been growing strongly because the world has been paying so much more for our coal and iron ore and because investment in new mines and facilities has been so strong. This looks likely to continue for some years yet.

But with this easy prosperity come two challenges: cyclical and structural. The mildness of the recession means we're already close to full employment, so it may not be long before the Reserve Bank is struggling to control a booming economy with interest-rate rises.

Neither public nor politicians has any real understanding of the way being at full employment constrains our ability to press ahead with every job-creating project we dream up. We're locked in a deficient-demand world view.

The structural problem has two elements: worrying about the perceived Dutch Disease problem (the temporarily high exchange rate wipes out other export industries, particularly manufacturing and tourism, so we're left with a vacuum when the resources boom ends) and deciding how to ensure we gain some lasting benefit from all the extra revenue flowing into government coffers.

If we're not careful we could end up with the same disastrous solution to both problems: pumping a lot of taxpayers' money into propping up declining manufacturing industries in the name of "value-adding". Their weak performance in this campaign suggests both sides are capable of such madness.

Our non-mining future lies in high-value services, not manufacturing, so the right answer is to increase our public (and private) investment in education, training and research. All such investment should raise our productivity in due course.

We all know our present social and economic infrastructure leaves much to be desired. We'll need to put a lot more money into it but this campaign's obsession with that thing I promised not to mention again suggests that, whoever wins, we won't be spending (and thus borrowing) as much as we need to.

Infrastructure investment adds to demand in the short term but also adds to supply (production capacity) in the medium term and productivity improvement (output per unit of input) in the longer term.

So, remembering our full-employment constraint, a great challenge facing the economic managers will be to (temporarily) constrain consumer spending to make room for more business investment and public infrastructure spending.

How? Good question. Maybe we could speed up the phased increase in compulsory superannuation saving.

Remember, however, that part of the solution to inadequate infrastructure is to use the existing infrastructure more efficiently. That means better pricing of it (with the net proceeds from that pricing also helping to fund additional investment). But better pricing requires a little political courage, something neither side has displayed in this campaign.

One area where supply-side reform is urgently needed is housing, where housing construction has fallen well behind the formation of additional households, forcing up house prices and rents. We need to remove the state and local governments' obstructions to medium-density housing and the release of serviced land.

The issue of population growth and immigration was raised in the campaign but not properly debated because both sides were just using it to dog-whistle about boat people.

The unthinking advocates of high immigration need to understand it makes a negative contribution to productivity improvement (by worsening the ratio of physical capital to labour) and demands increased investment in business equipment, housing and public infrastructure.

Unless the goal is growth for its own sake, it's a dumb way to go about raising material living standards (except those of the immigrants). It also greatly increases our difficulty in achieving targets for the reduction of our emissions of greenhouse gases.

It's all very well for the advocates of high immigration to say the underlying problem is one of inadequate infrastructure, not immigration as such. What do they propose to do about it - abolish the states? Who will pay for the extra infrastructure (on top of the existing backlog) and how will it be financed? By privately issued, but heavily publicly subsidised (and at least implicitly government-guaranteed) infrastructure bonds? That'll fix it. Not.

We do need to undertake a careful, evidence-based examination of what is a "sustainable" population, in which the economists, technological optimists and natural scientists box it out. All sides need to confront the elements of truth in the other sides' positions.

All this is what Julia Gillard and Tony Abbott should have debated over the past five weeks, but didn't. Whoever wins, the economy will lose.


Friday, August 20, 2010

Both sides fall victim to budget humbuggery

It's not just Tony Abbott who has been running from a debate on the economy. Both he and Julia Gillard have avoided serious discussion of the economy in this election.

Federal election campaigns usually focus on the economy, but this time both sides have been obsessed with something much narrower; the federal budget.

Managing the economy involves concern about inflation, unemployment, interest rates and - conventionally - what is needed to promote economic growth and further raise our material standard of living.

Promoting economic growth is about reforming government intervention in markets, reforming the tax system so it does less to discourage or distort economic activity, devoting sufficient resources to education, training and research, and ensuring adequate provision of infrastructure.

These days, it also involves taking steps to ensure the malfunctioning of the natural environment doesn't impose great costs and disruption on the economy - through climate change and other problems.

In that agenda, the federal budget is just a management tool, a means not an end in itself. And yet that's what it has become in this campaign.

Abbott's mantra has been his promises to ''end the waste, repay the debt, stop the new taxes and stop the boats''. The last of those is clearly non-economic, but the first three aren't so much economic as budgetary.

Why this diversion? Because, when you haven't thought much about the future or aren't game to broach in an election campaign the unpopular changes you know are needed (such as Gillard on climate change), all that leaves is the state of the economy.

Trouble is, it's going quite well. We have inflation and unemployment back under control. Interest rates are lower than they were at the last election.

Of all the developed economies, the one with the least cause for worry about the size of its budget deficits and the amount of its government debt is Australia. But the punters don't know that, and ''deficit'' and ''debt'' have such negative connotations they're an easy way to scare the untutored.

Most of the debate on deficits and debt has been silly and plays on voters' unsophistication. Both sides have solemnly promised what neither may be able to deliver: a budget surplus in three years time. Economists are hopeless at forecasting the economy, but projections of budget receipts and payments depend on those forecasts.

Though neither side is willing to admit it, should the world economy dip back into recession and China's demand for our exports falter, the budget will still be in deficit - as, in those circumstances, it should be.

Whether we return to budget surplus in three years or five matters little to the well-being of Australians. So great are the uncertainties that Gillard's promise of a surplus of $3.5 billion in 2012-13 and Abbott's promise of $6.2 billion are indistinguishable.

The squabbling over the costs of each side's promises is literally unreal. While, unsurprisingly, Treasury and the Department of Finance have a monopoly over the ability to produce costings they agree with, their record in predicting the ultimate cost of new policies is quite poor.

Both sides have made many expensive promises in this campaign, many of them involving waste. Both sides claim to have identified savings sufficient to cover the cost of their promises (and more in Abbott's case).

But if they were as worried about deficits and debt as they claim to be, they would have devoted all of those savings to reducing them.

What has passed for economic debate in this campaign has been dominated by narrow thinking, humbuggery, false precision and pseudo importance. Heaven help us.


Wednesday, August 18, 2010

Labor deserves credit, not death at ballot box

We may live in a globalised world but it hasn't made our election campaigns any less parochial and inward-looking. Perhaps in an effort to raise Australians' economic literacy, the Economic Society recently sponsored a national tour by Professor Joe Stiglitz, a Nobel prize winner and one of the world's most illustrious economists.

Some brave soul asked him if he'd learnt anything while he was here. Well, he said politely, there were a few things that had puzzled him. He couldn't understand why we didn't know the success of the Rudd government's budgetary stimulus - explained by its size, timing and design - was the envy of the other G20 countries.

He couldn't understand why we were so worried about budget deficits and debt when our accumulated federal government debt was about 5 per cent of gross domestic product, whereas just one year's budget deficit in the US was 10 per cent of its GDP. And he couldn't understand why so many people were opposed to requiring the mining companies to pay a fair price for the use of our resources.

Advertisement: Story continues below
Now more than 50 Australian economists have issued a statement saying they're ''convinced by the evidence that the co-ordinated policies of the Australian Labor government have prevented the Australian economy from a deep recession and prevented a massive increase in unemployment''.

Economic management is the dominant issue in almost every election campaign and I don't imagine it's much different in other countries. But that Labor could be in danger of losing the election after doing such a good job of guiding the economy through the worst global recession in 70 years is remarkable.

The usual pattern is for governments to be re-elected until finally they preside over a recession, when they're promptly tossed out. That's true of the Whitlam government (recession of the mid-1970s) and the Fraser government (recession of the early '80s). It's also true of the Hawke-Keating government (recession of the early '90s) although, thanks to the miscalculations of John Hewson, Paul Keating's execution was delayed until 1996.

The exception to the rule is John Howard. After more than 11 years he was tossed out without presiding over a recession. Indeed, the economy was booming at the time.

I have to admit that, back in 2007, I thought this wasn't a good election for Kevin Rudd to win. A recession was overdue, it was bound to occur within his first term, he'd get the blame and be tossed out after only three years. Right risk; wrong logic.

Much more than in the past, this downturn was very much the cause of external factors, in the form of the global financial crisis. But to the surprise of close observers, including the government and its econocrats, the recession proved to be so mild and short-lived many people have concluded there wasn't one. I'm sure many people who don't follow these things closely have since concluded the whole thing was a media beat-up.

(The media didn't invent the collapse of various local fringe financial institutions, nor the 0.8 per cent fall in real gross domestic product in the December quarter of 2008 and the weak growth in later quarters, nor the 230,000 rise in unemployment and the bigger rise in underemployment, nor the much tougher borrowing conditions for small business, nor the present weakness in retail sales and home building as the effects of budgetary stimulus have worn off.)

Many factors contributed to the mildness of our recession: the absence of serious banking problems, the strong growth in immigration, China's rapid bounce-back following its own massive stimulus, and the Reserve Bank's 4.25 percentage point cut in the official interest rate.

But like most (although, of course, never all) economists, I have no doubt about the central role of the Rudd government's large, early and carefully targeted budgetary stimulus. Its impact is clear from the statistics, including the remarkably early recovery in business and consumer confidence.

Most voters aren't interested in that kind of causal detail, of course. By their usual simple standard - did you or didn't you preside over a noticeable recession? - the government has passed with flying colours. So why isn't it coasting to an easy election win?

Partly because of its chronic inability to explain and defend its policies. But also because, if anything, the government has been too successful at staving off the usual symptoms of recession. There's little sense of gratitude, or even relief, because the period of fear - of losing your job, of wondering whether you might lose your home, of watching your kids spend months seeking a job - was too brief.

Our adversarial political system means the opposition always needs to find fault with the government's performance. It would dearly love to have been able to berate the government for its failure to hold off recession and prevent a huge rise in unemployment.

In the absence of that, however, the Liberals have switched to the claim that Labor has been on an unnecessary spending spree. It has racked up a frightening level of government debt to be left to our grandchildren and, if that wasn't bad enough, most of the money has been wasted.

There has been waste. Trying to spend money quickly means a degree of waste is inevitable. But with the willing help of sections of the media, the Libs have left voters with a quite exaggerated impression of the extent of that waste.

We're being asked to believe Rudd and Julia Gillard invented government waste. It never occurred under Howard and would never occur under an Abbott government.

But in all the hypocritical talk of waste, a far more important form of waste has been forgotten: the waste of material production and the waste of human well-being had the rise in unemployment not been stopped at 675,000 souls and been allowed to reach the 1 million originally feared.


Monday, August 16, 2010

Blowing the whistle on unfair costings game

I refuse to dignify the parties' predictable squabbling over the cost of each other's promises by taking it seriously. I don't know who's right and I don't much care. There are more important things to worry about. It's a three-yearly farce that drips with hypocrisy and fake importance.

I'm not sure why the parties always fall to furious arguing about Costing Blunders. Perhaps it's always started by the government of the day - because it's seeking to exploit the advantage of incumbency - and whoever's in opposition feels obliged to muddy the water by sniping back at the government.

These arguments are so arcane I'm sure the swinging voters at whom election campaigns are aimed take zero interest. So perhaps the pollies carry on about costs because it makes them look active and responsible, while distracting journalists from inquiring into more important matters.

It's the gross unfairness of the game that turns me off. Governments have year-round access to Treasury and the Department of Finance to get their costings done by the experts, using a process of iteration: "If you do it that way, minister, it will cost you 2X, but if you change this detail here the cost falls to X."

Governments pepper the econocrats with what-if questions in the weeks before the start of the election campaign. So only if they really cock things up are their costings ever found wanting when their promises are submitted to the people who costed them in the first place.

Oppositions, on the other hand, get no access to such official advice. They have to hunt for clues as to what things cost or pay an accounting firm big bucks to do their costings and, likely as not, get them wrong because the relevant information is so closely held by the econocrats.

This game of both sides submitting their promises to the econocrats for costing arose from Peter Costello's Charter of Budget Honesty. He knew it was stacked in the government's favour. Labor whinged repeatedly about the unfairness of it all and sought to minimise the (high) risk of embarrassment by submitting its costs at the very last minute.

In power, however, Labor's reforming zeal evaporated and it has delighted in turning the screws on the Libs as they did on it. And these guys wonder why they have lost so many supporters and are struggling to win what should have been their easiest-ever election.

Lemme give you a tip, Wayne: "We're no worse than the other lot" isn't a great rallying cry.

In opposition Labor lacked the courage to challenge this unfair arrangement but, fortunately, the Natural Party of Government had no such inhibitions. It has used the occasion of the leak of a flaw in its costings (more likely to have come from Labor than the econocrats) to refuse to submit further promises.

Good. If oppositions refuse to play ball, some government will be obliged to introduce a fairer system if it wants to stay in this silly game.

Because they're not in government with the econocrats' advice on tap, all oppositions have difficulty saying how they would pay for their promises. They are never game to give the honest - and quite satisfactory - answer: if we win, Treasury will tell us how - that's what it's paid to do.

Treasury and Finance know where all the waste is. They also know how to tweak promises in ways that greatly reduce their cost.

So great is the pollies' proclivity for solving problems with a chequebook, however, that neither side has been able to stick to its vow to find savings to cover all the cost of its promises over the "forward estimates" (that is, until June 2014).

They searched out a loophole: promise to spend money beyond the forward estimates. According to my colleague Jessica Irvine's estimates, by last Wednesday Labor had made promises worth $6.6 billion in this never-never land, while the Libs had IOUs worth $6 billion.

No doubt both figures are higher by now. It's remarkable to think the punters' votes are being bought with promises to spend money after the next election.

While we're on the subject of government spending - when have we been off it ? - I trust you noted Tony Abbott giving notice at his campaign launch that, should he win, he'll pull the standard trick of incoming governments: declare a fiscal crisis and introduce a horror budget.

He said he would set up a "debt reduction taskforce" in his first week to "get to the bottom of Labor's waste and mismanagement, to see the real state of the government's books and to prepare a comprehensive plan to start repaying Australia's $90 billion debt". In one month an economic statement would be issued "outlining Australia's risks and opportunities and the new government's response to them".

It's known in the trade as Doing a Mother Hubbard. You come to office, discover to your horror the cupboard is bare, and say you have no choice but to break promises and make emergency spending cuts you didn't mention in the campaign.

It's a harder trick to pull off these days because the Charter of Budget Honesty's "pre-election economic and fiscal outlook" statement, signed off by the econocrats early in every campaign, is designed to ensure everyone knows the latest state of the books.

But Abbott would claim the extent of wasteful spending was far worse than expected. In politics, a wasteful program is one your heartland supporters have no interest in.

That's the point. Though some effort would be made to reduce net spending, the objective is to cut out your predecessors' pet programs and replace them with your own.

Should Abbott win, he's already taken out fiscal insurance.


Saturday, August 14, 2010

Miners moan, but we need our fair share

It's easy to forget that the future of the minerals resource rent tax - the most significant tax reform since the goods and services tax was introduced a decade ago - hangs on the outcome of this election.

Should Tony Abbott win, he won't proceed with introducing the mining tax in July 2012, meaning he won't proceed with most of the tax concessions the new tax would pay for.

Labor has justified the tax as necessary to give Australians a fairer share of the profits from mining the now hugely more valuable coal and iron ore deposits the community owns. Exploitation of these resources is subject to royalty charges levied by state governments, but these payments have failed to keep up with the resources' higher market value.

Against this, the Liberals have claimed this "great big new tax" would do great damage to the mining industry and hence the economy. The big three mining companies - BHP Billiton, Rio Tinto and Xstrata - initially agreed with this claim, but dropped their objections after the incoming Julia Gillard did a deal with them that significantly watered down the original "resource super profits tax".

However, the smaller coal and iron ore mining companies - which weren't part of the deal - now believe (correctly) they were dudded by the big boys and have continued their opposition, claiming the tax means "families will be hurt with job losses in every community across Australia".

It's not hard to see why miners would object to paying more tax, but the tax was recommended by the Henry tax review and it is hard to see why these eminent economists would advocate a tax that could damage the economy.

The very reason for levying a tax on the "economic rent" derived from mining (that is, on the "super-normal profit" earned in excess of the "normal profit" needed to keep the mining companies' resources employed in the mining business) is to ensure the tax does not discourage mining activity.

Indeed, the review argued that, as well as raising revenue that could be used to reduce other, less efficient taxes, the resource rent tax would tax the resources sector more efficiently. That is, over time it would lead to a bigger mining industry, not a smaller one.

As originally proposed, the tax had three main advantages in terms of encouraging the efficient allocation of resources. First, using an increase in the tax on immobile resources (such as minerals) to finance a reduction in the tax on internationally mobile resources (such as financial capital, via company tax) would improve Australia's ability to compete against other countries in attracting foreign investment.

Second, using the tax to effectively replace state royalties would do much less to discourage mining activity. Royalty payments are inefficient because they're levied either on the volume of minerals mined or on their market price. This means royalties take no account of the cost of mining the minerals, which varies with the quality of the mineral being mined and how hard it is to get at.

The effect is to discourage the mining of low-grade deposits and discourage miners from continuing to mine the more costly, deeper-down minerals once the less costly stuff near the top has been won.

Third, the royalty system does nothing to recognise the high risks involved in setting up a mine. You can spend a lot of money, then discover it isn't profitable after all. The royalty system ignores all your costs, but starts charging you from the first tonne you manage to produce.

The great (but much misunderstood) beauty of the original resource super profits tax was it went as close as it practically could to the symmetrical treatment of profits and losses. You'd pay 40 per cent tax on your net profits, but if you incurred a net loss the government would cover 40 per cent of it. If you couldn't immediately deduct the 40 per cent from other mining tax payable, you could carry it forward, with its real value preserved by indexation to the long-term bond rate. If you abandoned the mine as unprofitable, the taxman would refund 40 per cent of your indexed accumulated loss.

Many critics of the tax got terribly muddled over this unfamiliar arrangement, accusing the government of using the (risk-free) long-term bond rate to measure the economic rent, when everyone knew you should use the risk-adjusted rate of return.

They failed to see it was the government guarantee of 40 per cent of losses that took account of risk. This recognition of risk meant fewer firms would be discouraged from undertaking risky investments by the tax system's failure to make adequate allowance for those risks.

So, as originally designed, the mining tax was highly efficient in its effect on the allocation of resources. Trouble was, it would have raised more than double the revenue Treasury originally estimated. That was the real thing bugging the big three companies.

Gillard should have responded merely by halving the rate of the tax from 40 per cent to 20 per cent. Instead, she cut it to an effective 22.5 per cent and butchered its design for good measure. In the process, she greatly reduced - but didn't eliminate - its efficiency benefits.

Originally, the tax involved a complete, up-front rebate of state royalties; now all you'd get is a deduction against any mining tax you owe. Originally, the tax applied to all minerals; now it applies only to coal and iron ore, with an exemption for those firms owing less than $50 million in mining tax. Originally, 40 per cent of losses were guaranteed by the government; now 7 percentage points have been added to the bond-rate "uplift factor" (which arbitrarily leaves some projects better off and some worse off).

It was always the case that virtually all the new tax was to have been paid by the big three companies; in some years, more than all. In other words, excluding the other minerals and the coal and iron-ore tiddlers may actually have saved the government revenue. If so, those other firms are worse off under the changes. They'd remain subject to all the drawbacks of the state royalty system. And fewer mining projects are likely to be started because their potential promoters will find the prospect of early losses more daunting.

Even so, a butchered mining tax would be better than no mining tax.


Wednesday, August 11, 2010

Gillard's Law of economics at a crass roots level

Frederick Taylor, the American inventor of "scientific management" a century ago, believed workers were dumb and lazy. So the tasks they were required to perform had to be broken down into the simplest of steps and they needed to be closely supervised. The only way to motivate them was by paying piece rates - what today we'd call "performance pay".

I'm sure Julia Gillard would never admit to regarding "hardworking Australians" as dumb and lazy. But she believes school teachers need to be spurred to greater effort by "a bonus payment under a new performance framework".

This is in addition to her plan for rewards of up to $100,000 to the 1000 schools that each year show the most improvement in attendance, literacy and numeracy or, in the case of high schools, year 12 results and the number of students going on to further education, training or work.

Top performers, about 10 per cent of teachers, would receive annual bonus payments of between $5400 and $8100, determined by the achievement of their students, their contribution to the school community and their participation in extracurricular activities.

I doubt the wisdom of this idea. I can understand why company boards feel they need to pay executives extra money to get off their backsides but teachers are meant to be professionals and it's a strange way to treat professionals.

Gillard professes to hold teachers in great respect (do I feel an election coming on?) but I suspect many of them would be amazed to hear it.

It's said the one thing economists agree on is: incentives matter. Trouble is, most economists assume the only incentives that matter are monetary. It wouldn't occur to them that offering teachers money for "contributing to the school community" contains a contradiction.

Teachers contribute to the school community and take part in extra-curricular activities because they want to. I've seen teachers putting extraordinary amounts of their time and effort into preparing kids for a school play, coaching debating teams and so forth. They do it because they regard the activity as worthwhile and of benefit to their kids, but also because they enjoy doing it.

It would be nice to think these intrinsic motivations - doing things for their own sake - could be pepped up by adding money (an extrinsic motivation, where you do things because of external benefits they bring). That's what economists assume can be done. Gillard, clearly, has started thinking like an economist.

But as I discuss in my new book, The Happy Economist (Allen & Unwin), psychologists have discovered it doesn't work that way. Economists have something called Gresham's Law: bad money drives out good. It turns out monetary motives drive out non-monetary motives.

Once you start paying people to do good works the selfish, materialist mentality takes hold and they stop doing those things unless they're paid. People who did good works because it made them feel good about themselves no longer feel that way. Those who contribute to the school community without winning a bonus may be discouraged in their well-doing.

So, should this scheme be implemented, don't expect a surge in School Spirit (as it was called at my school) and don't be surprised if it leads to a decline in teachers' second-mile contributions.

If I'm right, we will have discovered Gillard's Law.

This crass attempt to motivate teachers is symptomatic of the election campaign. More than ever it's been obsessed by money: budget deficits, public debt, wasteful spending. The only major non-monetary issue has been our intense objection to foreigners entering our territory without permission.

Both sides conduct their campaigns on the assumption we're quite selfish and mesmerised by money. For individuals, both sides have rolled out monetary bribes: cash for clunkers, higher family benefits for the parents of teenagers, incentives for age pensioners to do paid work, a more generous paid parental leave scheme. For marginal electorates, a new road or building.

Although it's been hidden by the negativity of this campaign and its obsession with budgeting, the underlying assumption of both sides is that the job of governments is to continually raise our material standard of living because this is what will make us happy.

They seem oblivious to the evidence, recounted in my book, that decades of rising living standards have done nothing to increase people's happiness or "subjective well-being".

It's time politicians reached a more enlightened view of what they could do to increase national happiness. They could start by rethinking their attitude to work.

The economists' model assumes we work only for the money it brings us. The rationale for Work Choices was: give employers more freedom to hire and fire, to call people in to work at times when it best suits the business without penalty payments, and the greater efficiency with which labour is deployed will raise our material standard of living to the benefit of all.

In truth, most people gain a lot of satisfaction from their work. That satisfaction can be diminished if people become less secure in their jobs and in the hours and days of the week they'll be required to work. An understanding of this seems implicit in Labor's opposition to Work Choices and in Tony Abbott's promise not to reintroduce it.

But why not make that understanding explicit? If work is a primary source of our happiness - as the evidence says it is - why not encourage employers to see the provision of secure, satisfying work as an end in itself, a primary reason for the existence of the business?

Why not help employers see that happy workers contribute more to the success of the business (or the school) - as the evidence increasingly says they do?

Monday, August 9, 2010

Claims of stimulus waste were greatly exaggerated

Media reporting and opposition politicking have left many people with the impression much, if not most, and maybe even all of the billions spent on school buildings under the Rudd government's stimulus package has been wasted.

It's an impression based on the piling up of unproved anecdotes about waste or rorting of particular school building projects. Which means it's an impression that's not genuinely "evidence-based".

Enough anecdotes have been produced to demonstrate that some degree of waste has occurred. But that's hardly surprising: there's a degree of waste involved in most spending, public or private.

The real question is how significant that waste has been. And no amount of piling up of unproved allegations can satisfactorily answer that question. Only a thorough investigation of the complaints can determine the extent of the waste and the reasons for it.

It's important to understand - as most people don't - that news reporting practices aren't intended to give us a representative picture of what's happening. Indeed, what's "newsworthy" is often quite unrepresentative.

News focuses on the unusual not the usual, the bad news not the good, the contentious not the widely accepted. (That's why climate change-denying scientists get a degree of media publicity out of proportion to the relevance of their qualifications or how representative they are of scientific opinion.)

This is why you wouldn't expect the media to do justice to the reassuring conclusions of the independent taskforce established to investigate complaints about the Building the Education Revolution spending.

For one thing, reassurance isn't very newsworthy. For another, any critical comments will be given more prominence than generally approving comments.

But there's more to the school building issue than just the limitations of news reporting. The complaints have been seized upon and played up by elements of the media and others with either partisan or ideological motives for seeking to discredit the use of budgetary stimulus in response to the downturn in our economy prompted by the global financial crisis and the world recession.

These people want us to conclude there was never any threat to the economy, thus making the stimulus spending unnecessary and, as it turned out, quite wasteful. Those with an ideological opposition to fiscal stimulus want us to conclude it NEVER works.

That's why I've read for myself the interim report of the taskforce, chaired by Brad Orgill, and want to give you a balanced account of its findings.

The taskforce was established to receive and investigate complaints about the school building program and to determine whether schools are achieving value for money. So far it has received complaints affecting 254 schools, representing only 2.7 per cent of all schools involved in the program.

Almost all the complaints relate to the part of the program that promised to build and upgrade infrastructure in all the nation's primary schools. The $14 billion cost of this element accounts for almost 90 per cent of the total cost of the program.

It will have delivered more than 10,500 construction projects to more than 7900 primary schools by late next year. About a third of the money is going on multi-purpose halls, almost 30 per cent on classrooms and a quarter on libraries, with the remainder going on covered outdoor learning areas and other things.

Spending of the money is being administered by 22 state government, Catholic and independent school authorities. Although the NSW government accounts for 22 per cent of the projects, it attracted 56 per cent of the complaints. The Victorian government, with a 12 per cent share of projects, attracted 20 per cent of the complaints.

More than half the complaints relate to value for money. "From our investigations to date, the majority of complaints raise very valid concerns, particularly about value for money and the approach to school-level involvement in decision making," the report says.

The report acknowledges - as many of the critics don't - that the primary reason for spending the money was to help counter the downturn in the economy by providing employment for building and construction workers throughout the country. It was also hoped the new buildings would improve the quality of our kids' education.

The report finds the stimulus "prevented many construction organisations from reducing staff or the size of their operations to match an otherwise decreasing workload resulting from the global financial crisis".

But the stimulus motive meant it was important to get the money spent quickly and this involved a trade-off. It meant less time for consultation with individual schools and less choice and customising of projects. That meant a degree of waste and, certainly, dissatisfaction on the part of some schools.

Cost per square metre was very much higher in NSW government projects, mainly because of big project management fees, which were 5 percentage points higher than normal. But these fees are partly explained by the high priority the NSW government gave to getting its projects completed quickly. Those states in less of a hurry incurred lower costs per metre.

The report says that, overall, delivering the projects within the short time-frame to achieve the economic-stimulus objective may have added a premium to normal costs of 5 to 6 per cent.

"Notwithstanding the validity of issues raised in the complaints, our overall observation is that this Australia-wide program is delivering much-needed infrastructure to school communities while achieving the primary goal of economic activity across the nation," the report concludes.

So the impression of widespread waste the media and people with axes to grind have left us with is greatly exaggerated.


Sunday, August 8, 2010


IQ2 Debate, Sydney City Recital Hall
Tuesday, August 10,2010

The older I get, the more I worry about saving the planet. The past 200 years have seen a phenomenal expansion in economic activity around the world. In that time, the world’s population has exploded from one billion to 6½ billion. Over the same period, the average standard of living of all the people in the world has increased sixfold. Multiply the two together and you see the amount of economic activity in the world has increased by a factor of 45.

I fear that this huge expansion of human activity over just the past 200 years has reached a point where it’s starting to do significant damage to the natural environment - the ecosystem. The trouble is that, while the economy grows exponentially (that is, at a reasonably steady percentage rate) - the ecosystem doesn’t. It’s fixed in size. This says there must be natural limits to growth, and I suspect we’re close to those limits. That certainly seems to be the case with global warming: 200 years of growing use of fossil fuels have caused a build-up of carbon dioxide and other greenhouse gasses in the atmosphere that exceeds the earth’s capacity to absorb it, and this is starting to interfere with the climate in ways that are soon likely to do great damage to the economy. And the threat to the planet isn’t just from global warming. We also have big problems with water, soil, fish stocks and the destruction of species. As I say, I fear we’re reaching the limits to growth in our use of natural resources.

And yet I have no hesitation in supporting the motion that ‘Only capitalism can save the planet’. Why? Because, as Maggie Thatcher used to say: TINA - there is no alternative. And because capitalism is malleable. It’s changed a lot over the past 200 years as circumstances have changed, and it can change further as our needs dictate.

If you doubt that, it’s because you’re reacting to a comicbook definition of capitalism. Capitalism is just a pejorative term for a market economy - an economy where the means of production are largely privately owned and decisions about supply and demand are made in markets, with those markets receiving a greater or lesser degree of guidance from government. The world’s experiments with alternatives to market economies - central planning as in the former communist countries or heavily regulated socialist economies (such as pre-reform India) have failed and been abandoned. Those economies that retain vestiges central control are generally moving closer to a market model.

Don’t fall for either criticism or praise of The Free Market. Free markets don’t exist - never have, never will. In all real world economies freedom is constrained by government intervention to a greater or lesser extent. That’s really the point: the choice we face is not between markets that are totally unregulated or markets that are so tightly regulated they cease to be markets. The answer to our problems will never be found at one extreme or the other; it will always be found somewhere in the middle. Finding the optimal degree of regulation isn’t easy, particularly because regulating markets is much harder than it looks. It’s terribly easy to get reactions you weren’t expecting. So there’s plenty of scope for debate about where the line should be drawn.

Clearly, with the global financial crisis, the line in America was drawn too far in the direction of deregulation, great damage ensued, and now it’s clear the line needs to be redraw further in the direction of regulating. Note that we didn’t have any significant problem with our banks. So does that mean the Americans had a capitalist economy and we didn’t? Of course not. It just means we drew the regulatory line in a better spot than the Yanks did.

If the other side wants to argue that market economies are far from perfect, they won’t get any argument from me. Of course markets are far from perfect. That’s particularly true in the case of the environment, where many scarce natural resources don’t have prices and so don’t get into the market process. They’re external to the market system and so don’t benefit from the market’s usual ability to ensure those resources aren’t wasted or used to excess. But that just means governments have to find ways to get prices on them and thus get them into the market system.

Guess what? The planet is in danger and making the appropriate modifications to the capitalism system offers the best chance we have of saving it.


Saturday, August 7, 2010

Don't be fooled by debt spin

In an ideal world, the economic debate between the two sides in election campaigns would leave voters with an accurate picture of the issues and choices. If one side said something wrong or misleading, this would be quickly refuted by the other.

Unfortunately, it doesn't work like that. Both sides are seeking votes, not enlightenment. When one side makes a misleading but seemingly persuasive point against the other, the reaction may be to change the subject rather than correct the error.

Rather than push them further apart, competitive pressure tends to push both sides towards the centre ground. So it may suit both to perpetuate the same misconceptions.

One simple truth that gets lost in election campaigns is that the primary responsibility for the day-to-day management of the economy rests not with the politicians, but with the bureaucrats in the central bank. It's they who determine the level of short-term interest rates, and it's the manipulation of interest rates ("monetary policy") that has most effect on the strength of demand (spending) in the economy.

The instrument of macro-economic management the elected government controls, the budget ("fiscal policy"), is secondary to monetary policy (although it does play a more prominent role during recessions). This leaves the denizens of Canberra (including journalists) with an inclination to exaggerate the role of fiscal policy in the management of the economy.

One way the Liberals do this (so far it hasn't suited Labor to run this line) is to exaggerate the effect of the budget on the level of interest rates. One rarely fully articulated argument is that budget deficits - which have to be covered by government borrowing - leave fewer funds available to be borrowed by the private sector and thus force up interest rates.

This would be true if our capital markets were cut off from the rest of the world but, since they're not, it isn't. Effectively, both our public and private sectors borrow in the global market, where their demand is too small to have any effect on world interest rates.

A better argument is that changes in the budget balance affect the strength of "aggregate" (total) demand in the economy and so affect the Reserve Bank's decisions about whether rising inflation pressure requires it to raise interest rates to discourage borrowing and spending. A fall in the budget deficit or a rise in the budget surplus could in this sense reduce upward pressure on rates.

But though this is true in principle, remember - as the denizens of Canberra keep forgetting - the federal government's budget balance is only one of the factors influencing the strength of aggregate demand. Other factors include the volume of exports versus imports, the terms of trade (the prices of exports and imports), the exchange rate and the strength of business and consumer confidence.

So, in practice, the effect of changes in the budget balance on the Reserve Bank's decisions about interest rates is usually pretty limited, as repeated comments by its governor make clear. But the whole Canberra obsession with (budget) deficits and debt, particularly in this campaign, can leave the unwary with an exaggerated impression of the federal budget's place in the scheme of things. You see this when journalists ask politicians when they plan to get "the economy" (or even "the country") out of deficit or out of debt. Sorry, the economy isn't in deficit, now or ever. It's just the budget that's in deficit, and there's a world of difference between the two.

Federal government spending is equivalent to only about a quarter of the economy as measured by gross domestic product, and even this exaggerates the budget's importance because much government spending merely involves transferring money between taxpayers and welfare recipients rather than producing goods and services (which is what GDP measures). No, it's important to understand that, apart from being a device for managing its own incomings and outgoings, the federal government's budget is an instrument that has effects on the economy without being the economy.

That's important because it helps you see the budget is merely a means to an end, not an end in itself. It's there to serve the economy; the economy isn't there to serve the budget. It's the economy that matters because the economy is us - it's the sum of the economic dimension of our lives, all the consuming and producing you and I do.

There's been such extraordinary fuss about the budget and its balance in this campaign that the uninitiated could be forgiven for concluding economic management is all about balancing the budget and avoiding debt.

Rubbish. Economic management is about keeping unemployment and inflation low (fortunately, this is the bit the Reserve Bank takes primary responsibility for). In conventional terms, it's about pursuing economic growth so as to continually raise our material standard of living.

To the more enlightened, it's about ensuring economic activity doesn't lead to the malfunctioning of the ecosystem, the most pressing instance of which is global warming. Both sides are running from their responsibility to combat climate change; their obsession with deficits and debt is a diversionary tactic. It will be a long time before they face up to the deeper question of whether endless economic growth is compatible with preserving an ecosystem that doesn't grow.

Economic management is about reforming those government interventions that reduce the efficiency of resource use without sufficient social justification. It's also about correcting market failures - instances where, left to its own devices, the market fails to maximise our wellbeing. That is, the federal government is responsible for micro-economic reform.

Government - state as well as federal - is responsible for ensuring the provision of certain vital services and infrastructure. We need, but don't have, sufficient investment in education and training - ranging from early childhood to schools to technical education to universities - to ensure a bright future for Australians and leave us with something to show for our mineral wealth.

To overcome present deficiencies and assure our future we need a lot more investment in economic and social infrastructure, particularly in transport and telecommunications.

If it's to happen, much of this investment will have to be financed by government. The notion that the Howard government left us with a debilitating infrastructure backlog used to be an incessant cry of the Labor government.

But the continuing obeisance to Costelloism - the doctrine that all public debt is bad - in this campaign suggests neither side would do much to deliver the infrastructure we need.


Wednesday, August 4, 2010

Stop beating about the bush and talk about Big Australia

Something significant has happened in this hollow, populist election campaign: the long-standing bipartisan support for strong population growth - Big Australia - has collapsed. Though both sides imagine they're merely conning the punters, it's hard to see how they'll put Humpty Dumpty together again. Which will be no bad thing.

The original bipartisanship was a kind of conspiracy. The nation's business, economic and political elite has always believed in economic growth and, with it, population growth, meaning it has always believed in high immigration.

Trouble is, stretching back to the origins of the White Australia policy, the public has had its reservations about immigration. Hence the tacit decision of the parties to pursue continuing immigration, but not debate it in front of the children. That's why we've never had a formal population policy.

John Howard used his harsh treatment of boat people to divert attention from his rapidly growing immigration program. Kevin Rudd continued the high immigration, but without the camouflage.

Growing punter angst about the return of the boat people collided with Rudd's announcement of Treasury's latest projection that, given various assumptions, the population could reach 36 million by 2050 and his happy confession to believing in a Big Australia. The punter reaction was negative. Rudd never used the phrase again, but appointed a minister for population whose main job was to repeat that the 36-million figure was merely a Treasury projection, not a policy or a target.

Fanned by the shock jocks and an opportunist opposition, the angst about boat people grew. In her efforts to neutralise the asylum-seeker issue - and, no doubt, informed by focus-group research - Julia Gillard judged it necessary to say she did not believe in a Big Australia. She wanted an Australia that was sustainable, and had added that word to the population minister's title.

But then she claimed population had nothing to do with either natural increase or immigration, which suggests her intention was to make soothing noises rather than change policy. Not to be outdone, Tony Abbott popped up with a policy to get immigration to levels "we believe are economically, environmentally, and politically, if you like, sustainable". He planned to rename the Productivity Commission the productivity and sustainability commission and get it to advise which population growth path it considered sustainable.

Gillard and Abbott have attracted criticism from commentators wedded to the old way of doing things, but the end of the conspiracy of silence is a good thing. Whatever the public's reasons for frowning on immigration, it does have disadvantages as well as advantages and the two ought to be weighed and debated openly.

The two leaders' adoption of the term "sustainable" has been attacked as vacuous - who, after all, would want any policy that was unsustainable? - but we do need to be sure the population policy we're pursuing is sustainable. That, in Abbott's words, it does not "rob future generations of the quality of life and opportunities we currently enjoy".

It's true politicians and economists have used the term to mean whatever they've wanted it to mean, but that's why it needs to be held up to the light. I suspect those scientists who argue we're close to the limits of our natural environment's "carrying capacity" are right, and the economists' airy argument that technological advance will solve all problems is wrong.

So let's get both sides out of their corners to debate the issue in front of us. We can't continue treating the economy like it exists in splendid isolation from the natural environment. And even when you ignore the environmental consequences, the proposition that population growth makes us better off materially isn't as self-evident as most business people, economists and politicians want us to accept. Business people like high immigration because it gives them an ever-growing market to sell to and profit from. But what's convenient for business is not necessarily good for the economy.

Since self-interest is no crime in conventional economics, the advocates of immigration need to answer the question: what's in it for us? A bigger population undoubtedly leads to a bigger economy (as measured by the nation's production of goods and services, which is also the nation's income), but it leaves people better off in narrow material terms only if it leads to higher national income per person.

So does it? The most recent study by the Productivity Commission found an increase in skilled migration led to only a minor increase in income per person, far less than could be gained from measures to increase the productivity of the workforce.

What's more, it found the gains actually went to the immigrants, leaving the original inhabitants a fraction worse off. So among business people, economists and politicians there is much blind faith in population growth, a belief in growth for its own sake, not because it makes you and me better off.

Why doesn't immigration lead to higher living standards? To shortcut the explanation, because each extra immigrant family requires more capital investment to put them at the same standard as the rest of us: homes to live in, machines to work with, hospitals and schools, public transport and so forth.

Little of that extra physical capital and infrastructure is paid for by the immigrants themselves. The rest is paid for by businesses and, particularly, governments. When the infrastructure is provided, taxes and public debt levels rise. When it isn't provided, the result is declining standards, rising house prices, overcrowding and congestion.

I suspect the punters' heightened resentment of immigration arises from governments' failure to keep up with the housing, transport and other infrastructure needs of the much higher numbers of immigrants in recent years.

This failure is explained partly by the rise of Costelloism - the belief all public debt is bad - but mainly because the federal hand has increased immigration while the state hand has failed to increase housing and infrastructure.

At its best, the message to the elite from the unwashed of the outer suburbs is: if you want more migrants, first get your act together.


Monday, August 2, 2010

Labor's no worse, and no better, than the Libs

To the superstitious, the meaning is clear: Julia Gillard and her Labor mates must be OK on economic management, otherwise God wouldn't have let her off the hook by causing the quarterly inflation reading to be low and thus averting a mid-campaign rise in interest rates.

Or perhaps all it proves is that God is a woman.

But there's a better reason for believing Gillard is a genuine fiscal conservative: the revelation that, as a member of Kevin Rudd's Gang of Four, she queried the cost of the decisions to introduce paid parental leave and significantly increase the age pension (while ensuring the benefit to sole parents was limited and the benefit to people on the dole non-existent).

As Tony Abbott has proceeded to demonstrate, Labor's paid parental leave scheme wasn't particularly expensive. Particularly not when you take account of how readily it can be justified in terms of both horizontal equity (reducing the biases facing women in the workforce) and economic efficiency (reducing the wastage of female skilled labour).

But the pension increase was hugely expensive, with costs that will keep growing until the end of time. And it was far more generous than the inquiry into pension adequacy recommended. It said there was no justification for increasing the married rate, but Rudd slung them $10 a week anyway.

Even with the single pension, the inquiry said it was mainly people who were renting who were struggling (the great majority of age pensioners own their homes outright), but Rudd ignored this targeted approach and granted all singles a $30 a week increase.

It was a profligate decision, one John Howard would never have countenanced. I've no doubt it was motivated by politics rather than fairness, being Rudd's attempt to buy the grey vote - a futile gesture. If Gillard queried the politics of it, she showed better judgment than her leader.

It's true the ever-growing cost of the pension increase was covered by ever-growing savings measures: phasing up the pension age to 67, tighter means testing of the pension and family tax benefits, reductions in superannuation tax rorts and means testing the private health insurance rebate (a measure the Liberals have blocked in the Senate).

But the opportunity cost of using those (eminently justified) savings to cover the cost of a needlessly generous pension increase is that they're no longer available to help return the budget to structural balance.

So if Gillard was querying the cost of the pension increase, good on her. Just a pity she didn't push harder.

But there's a deeper conclusion to be drawn. It soon became clear Rudd, the self-proclaimed fiscal conservative, was addicted to spending. Even so, he made sure his stimulus measures were T-for-temporary, enunciated a plausible "deficit exit strategy" and stuck to and strengthened it in his last budget.

I concluded the two purse-string ministers in the Gang of Four - Wayne Swan and Lindsay Tanner - were working hard to keep Rudd's spending proclivity in check and make his professed fiscal conservatism a reality.

Now, however, it's clear they were getting strong support from the third member of the quartet, Gillard. That's a good sign.

But though budgetary responsibility - sticking to the medium-term fiscal strategy of achieving budget surpluses, on average, over the economic cycle - is important, it's not the be-all-and-end-all of economic management that Abbott and Joe Hockey portray it as.

It's an inadequate substitute for courageous micro-economic reform, starting with immediate implementation of an emissions trading scheme. No party that squibs on acting early to protect the economy from the hugely adverse consequences of climate change can claim to be a good economic manager.

It's noteworthy that once the Liberals had abandoned their commitment to using a price-based approach to combating climate change, it didn't take Labor long to abandon its own commitment.

Similarly, once the Libs set their face against the highly equitable and economically efficient resource super profits tax, it wasn't long before Labor went into retreat.

It could merely have slashed the rate of the tax when it discovered how much more it would raise than had ever been contemplated, but for good measure it butchered the design of the tax, greatly reducing its economic efficiency benefits as a substitute for the inflexible state royalties.

And it's the Liberals' Costello-instigated obsession with budget deficits and public debt (though certainly not current account deficits and foreign debt) that does most to explain why Labor has donned the same hair shirt. Labor began by arguing we needed to overcome the Howard government's neglect of economic infrastructure, but soon succumbed to Costelloism.

See what this means? This government is so lacking in self-confidence on matters economic it takes its lead from its political opponents - even when they're led by that unabashed economic irrationalist, Abbott.

Elect Gillard and what you'll get is Abbott populism at one remove. What you won't get is a government with the confidence to decide for itself what the economy needs and what is politically achievable, if there is a willingness to put up a fight and lose a bit of skin.

Why is the Rudd-Gillard government so reactive when it comes to economic management? Because, when the public is asked which party is better at managing the economy, its answer almost always favours the Liberals. By 47 per cent to 35 per cent, according to a recent Newspoll.

The public is convinced the party of the workers wouldn't be much good at running the economy. And in its heart, Labor fears the public is right.

If by some chance Labor fails to get itself re-elected, there'll be one overwhelming explanation for such an extraordinary result: the punters aren't impressed by timidity and lack of conviction. Bring back Paul Keating.