Monday, March 21, 2011

Economists part of Inside Job (Movie previews!)

It always takes the movie world a while to catch up with real life, but it's finally caught up with the global financial crisis. There's the Oscar-winning documentary Inside Job and a classic Hollywood job, The Company Men. I recommend both.

Inside Job deals with the origins of the crisis on Wall Street; The Company Men deals with consequences on Main Street from the resulting Great Recession. Let's start with the "real economy".

America's unemployment rate started rising in October 2008, reaching 10 per cent a year later. It's still about 9 per cent. Say it quickly and it doesn't sound too bad. People lose their jobs when the economy turns down - what else is new?

The great strength of The Company Men is the way it shows us what happens to the lives of three men who lose their jobs when their company decides to "rightsize". These aren't ordinary workers, they're executives close to the top of the tree, which gives them further to fall.

They are well-paid guys who seem to have committed themselves for almost all they earn. First is the humiliation of their lowly status at the outplacement agency and then the disillusionment as their repeated efforts to find another job get nowhere.

At first they attempt to conceal the shame of their unemployment from their children, neighbours and relations. Then comes the steady divestment of the big toys they can no longer afford. Marriages are strained by money worries. Their self-identity came from their job; their job is no more.

They were let go because their company's share price had fallen in the crash and something big must be done to restore it. But every company's share price fell, so what's the problem? The problem turns out to be the chief executive's need to raise the value of his share options. Whether on Main Street or Wall Street we see the new morality of corporate capitalism: look after No. 1 and don't feel any responsibility for the consequences of your actions for customers or colleagues.

In the words of one reviewer, Inside Job is the story of a crime without punishment. Wall Street's reckless behaviour caused the crisis and the huge damage it did to businesses, workers and retirement savings in America and Europe.

The banks were bailed out at great expense to the taxpayer, but so far almost no one has been punished for misconduct or negligence. Many of the perpetrators walked away with millions. The payment of outrageous bonuses hardly skipped a beat.

The film's graphics do a good job of explaining the central role - and the madness - of toxic derivatives such as collateralised debt obligations and credit default swaps.

Many of the docos you see on political and economic themes are acts of left-wing self-indulgence. Not this one. The sense of outrage it builds up in the audience is eminently justified. Indeed, it leaves you wondering how the American public has been so easily diverted from demanding Wall Street be brought to heel.

The outrage arises as you realise Wall Street is virtually a law unto itself. It was progressively deregulated at its own urging by congresses of both colours. Now its immense wealth and lobbying ability prevent it from being effectively reregulated.

For the most part, administrations' key economic regulators - Federal Reserve governors (Paul Volcker, Alan Greenspan) and Treasury secretaries (Robert Rubin, Hank Paulson, Tim Geithner) - come from the upper reaches of Wall Street.

When the big business-dominated Bush administration was replaced by the reformist Barack Obama, Republican-affiliated Wall Streeters were replaced by Democrat-affiliated Wall Streeters.

But it's not just the politicians who are compromised. The film's director, Charles Ferguson, shows how many of America's big-name academic economists are also on the Wall Street payroll. He outlined the case against economists in an article in The Chronicle of Higher Education. Ferguson's leading academic villain is Larry Summers of Harvard. He has long been a champion of privatisation and deregulation and as deputy secretary then secretary of the Treasury in the Clinton administration he oversaw the repeal of the Glass-Steagall Act, which had kept commercial banks separate from investment banks since the Depression.

Between 2001 and his entry into the Obama administration as director of the National Economic Council, Summers made more than $20 million through consulting and speaking engagements with financial firms.

Martin Feldstein, also of Harvard, a major architect of deregulation in the Reagan administration and president for 30 years of the non-government National Bureau of Economic Research, was on the board of the failed insurance giant, AIG, which paid him more than $6 million, and also on the board of the subsidiary whose dealings in credit default swaps brought the company down.

Feldstein's arrogant performance in the film was exceeded only by that of Glenn Hubbard, chairman of the Council of Economic Advisers in the Bush administration and dean of Columbia Business School. He's an adviser to many financial firms, resigning from the board of Capmark, a major commercial mortgage lender, shortly before its bankruptcy in 2009.

Frederic Mishkin, a professor at the Columbia Business School and a member of the Federal Reserve Board from 2006 to 2008, was paid $124,000 by the Icelandic Chamber of Commerce to write a paper praising its regulatory and banking systems, two years before Iceland blew up.

Laura Tyson, a professor at Berkeley and director of the National Economic Council in the Clinton administration, is on the board of Morgan Stanley, which pays her $350,000 a year.

Some of America's leading academic economists, from the most prestigious universities, make frequent pronouncements on public policy in the media, expecting to be venerated as disinterested experts. They rarely see a need to disclose their conflicts of interest.


Saturday, March 19, 2011

When the price is right you're on the right track

if economists wore T-shirts what they'd say is PRICES MAKE THE WORLD GO ROUND. Conventional economists are obsessed by prices. It took me ages to realise that economics isn't actually about the economy. It's about markets. So economists tend to ignore those parts of the economy that don't involve markets, such as the production and consumption of goods and services that go on inside households.

Economic sociologists also study markets and what they see is the way unwritten rules of social relationships influence the behaviour of producers and consumers, sellers and buyers.

Economists, however, don't see any of that. What they see is the way prices adjust until supply and demand are in balance ("equilibrium"). They see the price mechanism as the fulcrum on which the market economy rests.

Sometimes economists say economics is the study of incentives. That's just a fancy way of saying they study prices. Lower prices are an incentive to consumers to buy more, but an incentive to producers to produce less. Higher prices create the opposite incentives. Higher wages (which are a price) are an incentive to work more, and so forth.

But what fascinate economists are relative prices - the price of this item compared with the prices of other items. They think changes in relative prices have an almost magical ability to change people's behaviour.

Inflation involves rises in the level of prices generally. Economists disapprove of inflation mainly because when the prices of everything are rising this makes it harder for people to see and react to changes in the thing economists really care about: relative prices.

Last week an assistant governor of the Reserve Bank, Dr Philip Lowe, gave a speech in which he predicted the resources boom would cause a significant change in the structure of Australia's industries. What would bring this change about? Changes in relative prices, of course.

The most basic relative price in this story is our terms of trade - the prices we get for our exports relative to the prices we pay for our imports. The super-high prices we're getting for our coal and iron ore make our terms of trade possibly the most favourable they have ever been and about 90 per cent better than their average for the 1990s.

The change in this relative price is the main reason for the change in another key relative price: our exchange rate - the price of our dollar relative to the price of the US dollar, the yen or the euro.

But Lowe points to some relative price changes that are much less remarked. One is the price of manufactured goods (such as clothing, footwear, furniture and floor coverings, vehicles, audio, visual and computing equipment) relative to the price of other goods and services.

The prices of manufactures have been falling relative to the prices of services around the world for many years. This is because productivity in manufacturing has improved faster than productivity in services and because more of the world's manufacturing is being done in developing countries where labour is cheap.

But in recent years that process has been accelerated in Australia by the appreciation of the dollar. So much so that the Australian retail prices of manufactured goods (many of which are imported) have not only been falling relative to the prices of other goods and services, but also falling in absolute terms.

Looking at the consumer price index over 2010, the prices of other goods and services rose by about 7 percentage points more than the prices of manufactured goods.

The next important change in relative prices is the price of "investment goods" (machinery and equipment) relative to the price of "output" (all goods and services produced in Australia). When the price of new machines is low relative to the price of the goods and services produced using those investment goods, investment in new machines tends to be high - which is just what we've seen over the past decade.

The relative price of investment goods tends to be cyclical, but there is also a clear downward trend over time. This secular decline is driven largely by technological improvements lowering the price of computing power. But, again, the decline over the past decade has been particularly large because of the high dollar (much machinery is imported).

The final key change in relative prices is the price of labour. For workers, what matters is their wage relative to the price of the goods and services they buy with that wage. Economists call this the "real consumption wage".

For firms, what matters is the wages they pay relative to the prices they get for the goods and services they produce and sell. This is the "real producer wage". Usually, these two relative wages should be pretty similar because the goods and services people buy are much the same as the goods firms produce.

In recent years, however, this correspondence has broken down because of the improvement in the terms of trade. By definition, Australian firms produce exports but not imports, but Australian consumers buy imports but not exports.

Since 2000, the economy-wide ("aggregate") real consumption wage has risen by about 25 per cent (great news for workers), whereas the aggregate real producer wage has risen by only about 10 per cent (good news for firms).

But these aggregate figures conceal big differences between industries.

In industries where productivity is improving quickly - such as manufacturing - the real producer wage tends to rise because competition passes the benefits of the higher productivity through to customers in the form of lower prices.

By contrast, in many service industries real producer wages have been pretty flat. And in mining the real producer wage has fallen significantly: although miners' wages have grown very strongly, the prices the mining companies have been getting for their coal and iron ore have risen infinitely faster.

See where this is leading? All the relative price changes we've discussed will be working to change the allocation of resources within the economy in the same direction: away from manufacturing (and other export or import-competing industries, such as tourism) and towards mining and those parts of the manufacturing and services sectors that hang off it.

Mining's share of total annual private and public sector investment spending has reached almost 20 per cent - roughly double its usual share - and may rise as high as

25 per cent before long.

However, the great bulk of the economy - the services sector, accounting for more than three-quarters of total employment - will be little affected.


Wednesday, March 16, 2011

We are watching our pennies, at last

Not so long ago people used to scandalise over the rate at which we were racking up credit card debt. Not any more. These days a new frugality is gripping us and credit card and other personal debt is growing at a snail's pace.

Starting in the mid-1990s, our return to low inflation caused interest rates to fall sharply and oscillate around a much lower level - remember when the mortgage rate was up at 17 per cent? - and this coincided with the banks becoming much keener to lend to ordinary mortals.

They pushed their credit cards, offering reward schemes as a new incentive, and inventing home loans that allowed you to redraw without fuss money you had paid off the principal. Whereas for decades people had tried to pay off their mortgage as quickly as possible, now they were seizing the opportunity to add to it.

The great bulk of the borrowing was for housing - including investment housing - but we also borrowed enthusiastically for cars and other durables, as well as hitting the credit card. Over the year to June 2007, outstanding credit card debt grew by more than 11 per cent. Add in personal loans and total personal debt (excluding housing debt) grew by 19 per cent.

Over the year to this January, however, total personal debt grew by less than 2 per cent. And over the year to February, the average credit card debt rose by less than 1 per cent - way below the rate of inflation - and the number of new cash advances fell by almost 2 per cent.

So what has changed? Probably a couple of things. The first is that we've adjusted to life in a world of easily obtained credit. We've borrowed hugely in the competition to obtain a better home, pushing the price of housing to unknown heights. Housing has now become much less affordable and it has occurred to us that house prices can mark time or even fall as well as rise inexorably.

After an uncharacteristic period of allowing the proportion of our collective equity in our homes to decline, we've returned to our accustomed position of increasing our equity by keeping ahead of our repayment schedule wherever possible.

Similarly, we seem to have gained a little more self-control when it comes to wielding our credit cards.

A second factor may be the lingering effect of the global financial crisis. Many Australian households may well have realised they were carrying far too much debt, which would leave them vulnerable (or, if you prefer, vonnerable) should they ever lose their jobs. (This is certainly what's happening with a vengeance in the United States and Britain.) If so, many people would be trying to avoid new commitments and repay old ones.

Another suggestion is that it's particularly the baby boomers who have changed their behaviour. In 2008 they witnessed the sharemarket crash slash the value of retirement savings - with share prices still not fully recovered - and now they've realised they need to knuckle down and start saving while there is still time.

Whatever the reasons, the figures say that whereas in the early noughties households had "negative saving" - their consumption spending exceeded their incomes - now they are saving almost 10 per cent of their disposable incomes. That's the highest our rate of saving has been since the mid-1980s.

Saving and borrowing are closely linked, of course - roughly, opposite sides of the same coin. So it shouldn't surprise that much of the money we're saving is being used to reduce our debts. (Nor should it surprise that, while many people are reducing their credit card balance, others are adding to it, so that total debt is still rising fractionally.)

We save by limiting our consumption relative to our income, but much of our spending - on rent or mortgage interest, council rates and electricity, for instance - isn't particularly discretionary. Where we have most discretion is in our spending at discount and department stores and it's these stores (plus newspapers dependent on retail advertising) that are feeling the pinch of our new frugality.

What goes with department stores? Credit cards. Why do so many people have trouble with credit cards? Professor Joshua Gans, of the Melbourne Business School, says many poor consumer decisions have two dimensions: sophisticated versus naive, and disciplined versus undisciplined.Sophisticated consumers are adequately informed about the products they are purchasing and about the mental biases which, if unchecked, may influence their decisions. Disciplined consumers are able to overcome their own biases, even if they aren't always well informed.

Ian McAuley, of the University of Canberra, has applied this matrix to credit cards. A sophisticated and disciplined consumer uses a credit card in the interest-free period and pays it off before the monthly deadline. Sophisticated but undisciplined consumers use the credit card, intending to pay it off, but when the time to do so arrives they suffer the bias of short-sightedness and go into high-interest debt.

Naive and undisciplined consumers use the credit card, perhaps to the limit, without even considering the opportunity to pay it off in the interest-free period.

Naive but disciplined consumers may refuse to use a credit card at all.

I doubt we've become much more sophisticated, but we do seem to have become more disciplined. Certainly, the figures say more of us - about 65 per cent - are paying off our accounts in full each month.


Monday, March 14, 2011

No one's trying to reduce government waste

Government waste is like the weather: everyone disapproves, but no one does anything about it. Oppositions accuse governments of creating it, but governments don't seem to try too hard to eliminate it.

And this doesn't seem to worry you and me too much because our main use for government waste is as an excuse to oppose every suggestion that we pay more tax - and, indeed, to resent the extortionate amount we pay already (always conveniently forgetting what we read time and again: that Australia's total tax burden is quite low compared with other advanced economies).

Were someone to magically eliminate all government waste, would we then be willing to pay more tax? Somehow, I doubt it.

This makes it likely we have an exaggerated view of the extent of waste. It suits us to believe waste is endemic. The sums we hear about seem huge - they are huge relative to our household budgets - but we're bad at putting them into the context of the billions of dollars our governments play with. We have no conception of how big Australia is when you add up its 8 million households and more than 1 million businesses.

That's my guess - that we have an exaggerated view of the extent of waste - but I can't prove it. I doubt if anyone has surveyed our impressions on the topic. Nor do we have any figures on the actual size of government waste, whether it's getting better or worse, or which side of politics has the worse record.

I guess no one's game to spend money measuring the extent of waste for fear of the talkback know-alls who'd say this was itself a waste of money.

And, of course, measuring waste wouldn't be nearly as easy as many of the sidewalk supervisors imagine. Waste is deceptively easy to allege, not so easy to prove and very hard to eliminate.

I've no doubt waste exists, and will always exist. There's plenty of waste in our own homes - the excess food we buy, the expensive gadgets we rarely use, the empty bedrooms, the kids who don't take advantage of the expensive educations we've provided, the holiday houses that are rarely occupied, the boats that rarely enter the water or leave their mooring - so why do we imagine governments could ever conduct their affairs without waste?

Because some degree of waste is inevitable it would nice to have some measure that allowed us to say whether its present level was excessive. And there are different types of waste. Often what the casual observer regards as waste merely reflects their lack of knowledge of all the circumstances.

Often there's a lot of subjective judgment involved. Is it wasteful to have bedrooms that are rarely occupied? Is it wasteful not to bother trying to rent out your holiday house when you're not using it? Or is it just the way you choose to enjoy your affluence?

At the government level, there's undoubted waste but there's also debatable waste. I may consider paying the family tax benefit to someone on your income a case of wasteful spending, but you probably disagree.

Tony Abbott and his colleagues are always accusing the Rudd-Gillard government of wasting money - as though waste was a recent invention - but when they're obliged to come up with their own list of spending cuts they're pretty light on. Too many possibilities that could cost votes.

It's no doubt a good thing oppositions carry on about waste - there'd probably more of it if they didn't. Even so, you don't get the feeling governments put much effort into hunting it down. They're always boasting about cracking down on petty welfare fraud, but not much else.

And when you consider how little publicity the media give to auditor-general certified waste, you get the feeling the public isn't all that worried about waste beyond using it to justify their objection to higher taxes.

One class of waste is ineffectiveness: government spending that doesn't achieve its stated objectives, or doesn't achieve them as well as some other program might. You'd think that, in this day and age, governments would put a lot of effort into assessing the effectiveness of their spending programs, but in this we lag well behind the Americans.

Perhaps because of the crowing they know the Opposition might do, ministers and their department heads have little enthusiasm for reviewing the effectiveness of their programs. They don't want the auditor-general poking his nose in and what evaluation occurs is usually pretty Mickey Mouse.

In the US, by contrast, it's common for Congress, when passing spending bills, to earmark a small proportion of the funds for program evaluation and to specify the rigorous methodology to be used. They've even got to the point where they're using randomised controlled trials. You have a treatment group and a (non-treatment) control group and you allocate participants between the groups by the toss of a coin.

Provided both groups are big enough, this approach makes it more likely the differences in outcomes between the two groups are the result of the treatment rather than extraneous factors.

Such an approach, which is widely used in medical trials, could be used to evaluate many - but not all - social spending programs.

And Dr Andrew Leigh, a federal Labor backbencher and former economics professor, has moved a private member's bill proposing we do just that. I'd like to see Abbott and the soon-to-be-elected O'Farrell government promising rigorous evaluation of spending programs. That would test their sincerity. And the Baillieu government in Victoria could get right in and do it now.

Saturday, March 12, 2011

A way to tackle carbon and keep everybody happy

As if we needed any reminding, the latest flare-up of politicking over putting a price on carbon shows just how difficult it will be to gain sufficient community agreement to take effective action against climate change.

With a government lacking the numbers in both houses, the Greens demanding a sackcloth-and-ashes scheme and an opposition determinedly putting short-term partisan advantage ahead of the national interest, how are we to reach agreement?

Well, Dr Frank Jotzo, of the centre for climate economics and policy at the Australian National University, thinks he's found a way. In a forthcoming paper he proposes a strategy that would respond to each of the conflicting interest groups' key concerns while still producing a scheme that stacks up economically and environmentally.

He starts by ignoring the political parties and identifying four key constituencies. First are environmentally concerned citizens and groups. These are deeply concerned about climate change and convinced of the need to reduce domestic emissions of carbon dioxide and other greenhouse gases. They'd like to see Australia making a constructive contribution to global action.

Second are the general citizens, who accept that more needs to be done about climate change, but are concerned about the possible effect on their cost of living, thus making them vulnerable to scare campaigns.

Third is the general business community, which is only weakly engaged in the public debate because it doesn't see climate change as a core concern. But it accepts that something must be done and sees an effective government response as a sign of commitment to reform and good government.

Fourth are emissions-intensive industries, which now seem to have accepted some form of emissions reduction policy is inevitable, but are focused on minimising the financial impacts on major emitters. The success of their lobbying resulted in the Rudd government's emissions trading scheme granting them many free emission permits and much permit revenue.

While some of these businesses would be happy to see policy action delayed, more of them want to reduce the effect of uncertainty about policy on electricity generators' decisions on new investments. The present hiatus creates a risk of disruption in electricity supply over coming years.

How could you come up with an arrangement that offered enough to each of those groups to achieve their support for action? Jotzo thinks the key to it is the leeway provided by a little-understood feature of the Rudd government's scheme, or any other plausible scheme.

Australia is a relatively small open economy whose carbon reduction scheme would be part of a global collection of national schemes which, collectively, would significantly reduce global emissions. It's the level of global emissions, not the efforts of any particular small country, which influences climate change.

Because the problem and the solution are global, the Kyoto Protocol and, no doubt, its eventual successor provide for the trading of emission permits between countries. This helps to minimise the economic cost of reducing emissions by allowing emissions to be reduced in those parts of the world where the cost of doing so is lowest.

If it's more expensive for me to reduce my emissions than it is for you to reduce yours, let me meet my obligation by paying you to reduce yours on my behalf.

Under the Rudd government's scheme it was always intended that Australian producers who needed permits to cover their emissions would be free to meet their obligations by purchasing emissions permits from overseas. This means the international price of emissions permits would set a ceiling for the market price of permits in our scheme.

It also means that, until the domestic price of permits reaches the international price, the domestic price and the rate at which it's set to rise can be detached from the achievement of the target for Australia's contribution to the reduction in global emissions.

Should the reduction in domestic emissions fall short of the target, the government can simply buy sufficient overseas permits to ensure the target is met. This decoupling allows us to phase in the carbon price - thus making it easier for firms and households to adjust to it - while still setting and achieving an ambitious target.

And this allows Jotzo to propose a strategy that "has the potential to deliver a worthwhile long-run policy outcome while working within the major concerns and interests of the four interest groups".

The strategy builds on last month's agreement between the government and the Greens to set a government-determined carbon price from next July, with provision to shift to a trading-determined price over the medium to long term as international uncertainties are resolved.

The first step is to ensure that, wherever the initial carbon price is set, it should be increased over time so that the price in the medium term (from 2015 to 2020) is high enough to create confidence that Australia's domestic emissions will begin to trend downwards within the next few years.

Remember, the expected future price of carbon is the major driver of present new investments in the assets - such as power plants, business machinery, transport infrastructure and vehicles, buildings and household appliances - that will shape future energy use and emissions.

The simplest way to achieve this is to legislate the path of the fixed price and then, once the switch is made to an emissions trading scheme, legislate the path of a minimum price below which the market price won't be allowed to fall.

The second step is to set the initial price at a level low enough to give people confidence the short-run effects on the economy will be manageable and to give households and businesses time to adjust.

This would reassure general citizens and the two business constituencies, demonstrating that a carbon price won't cause major economic disruption.

The third step is to ensure any assistance to emitters is tightly limited, determined by transparent rules, subject to sunset provisions and, above all, doesn't reduce their incentive to cut their emissions.

In using the proceeds from the sale of permits, the highest priority should be compensating households - particularly low- to middle-income households - for the rise in their cost of living but, again, this must be done in a way that doesn't reduce their incentive to cut emissions.

Finally, the scheme should include provision for the government to steepen the path of the carbon price, and lift the target to a 25 per cent reduction in emissions by 2020, in response to any increase in global ambition beyond what individual countries promised to achieve following the meeting in Copenhagen.


Wednesday, March 9, 2011

Money can ease the pain of disability

Did you know there's an expensive policy proposal Tony Abbott isn't opposed to? When it lobbed last week both sides made supportive noises about it so, thanks to the perversity of politics, it slipped past without getting the attention it deserves. It's the Productivity Commission's draft report on the government's desire to establish a national disability insurance scheme.

The scheme would cover people with severe disabilities present at birth or acquired through an accident or health problem, but not due to ageing.

It's estimated that about 680,000 people under 65 suffer a severe or profound limitation in their ability to engage in core human activities. Just under half of these have at least a daily need for help with mobility, self-care or communicating with others. But only about 170,000 are using disability services.

Among those with a profound inability to engage in core activities, about 40 per cent suffer from mental and behavioural disorders such as autism, Asperger's syndrome and intellectual disability. The next biggest groups suffer from diseases of the nervous system, such as multiple sclerosis, of the circulatory, respiratory or digestive systems, and of the musculoskeletal system.

It's easy to look at that list and think none of it applies to me and mine, thank God. That's the political problem: it's not that we have no sympathy for these people, it's that we prefer not to think about such unpleasant topics. But all of us are just a car or household accident away from joining their number.

My interest in the topic comes via my belief that governments should be seeking to maximise our subjective wellbeing - our happiness - not just our material standard of living. One of the best ways to increase national happiness is to reduce the deep unhappiness suffered by many of the disabled and their carers.

People with disabilities are able to adjust to their circumstances and find happiness - but not if the community's neglect allows their lives to be a hellish struggle. The report quotes a psychiatrist saying members of the profession regularly meet parents considering murder-suicide because of their inability to find adequate help for their child.

The present system - or lack of system - for helping people with disabilities has many deficiencies. The most obvious is that in all states there are insufficient resources and gaps in services, so that people with disabilities and their family carers bear too much of the cost.

People with similar levels of impairment get quite different levels of support, depending on the state they live in, whether they live in the city or the country and even the origin of their disability.

The present arrangements are "provider-centric" - organised for the convenience of the providers of assistance - which reduces the ability of people with disabilities and their carers to choose which services they use.

Services are generally narrowly prescribed and don't have the goal of increasing the person's ability to take part in normal life. There are too few opportunities for people to work or participate in the community if they're able to.

People with disabilities and their families often don't have a reasonable level of certainty about the future. In particular, the parents of children with profound disability often worry about how their child will be supported when they get too tired or sick, or they die.

There's a lack of co-ordination between agencies, seen in duplicated and inconsistent methods for assessing people and allocating services, and inadequate links between services provided by different governments.

Services often aren't portable between states, penalising people who move. And there are other injustices and inefficiencies, such as caring for young people with disabilities in aged care homes and keeping people in hospitals - thus blocking beds - because of insufficient funds for minor modifications to their homes.

The report proposes a new national scheme providing insurance cover for all Australians in the event of a significant disability. The scheme would fund long-term, high-quality care and support (such as accommodation, mechanical aids, transport, respite, day programs and participation in the community), but would not overlap with Medicare, social security benefits or aged care arrangements.

Each individual's needs would be assessed and they would be provided with a "support package" portable across state borders. People with a package would be able to choose their own service providers, ask a non-government support organisation to assemble the best package on their behalf and even cash out their allocation of funds and direct them to areas of need they thought more important.

There would be a strong emphasis on helping people participate in education, training and employment where possible. People would be given more opportunity to choose mainstream services rather than those from specialist providers.

A separate national injury insurance scheme would be established for people requiring lifetime care and support for catastrophic injuries, such as major brain or spinal cord injuries. It would be a no-fault scheme and would catch people whose injuries were covered neither by worker's comp or compulsory third-party motor insurance.

The agency overseeing the two schemes would be created by, and report to, federal and state governments. It would have a high degree of protection from political interference. By "insurance" is meant social insurance - the risk of disability is removed from the individual and shared by the group which, because of its sheer size, is most able to bear it without great pain: all taxpayers.

At present, governments - mainly state governments - are spending about $6.2 billion a year. The report estimates the new schemes would cost as much again.

The extra $6.3 billion a year could be covered by increasing the present Medicare levy from 1.5 per cent to 2.3 per cent of income but, rather than start another "great big new tax on everything" outcry, the report recommends just funding it out of consolidated revenue, leaving the government to worry about how it will balance its budget. Funding problem safely swept under carpet.


Monday, March 7, 2011

No more ignorant talk of a two-speed economy

The more economists examine it, the more they explode the seemingly self-evident truth that we're living in a two-speed economy.

Why do people keep saying this? I think they're saying that whoever's benefiting from all the talk of a boom, it ain't my state or my industry. In short: I see no evidence of any boom around me and I'm certainly not getting any benefit from it.

If there is a boom, they seem to be saying, it's limited to the mining industry while the rest of the economy is struggling. Similarly, Western Australia and Queensland may be doing OK, but the other states and territories aren't.

There's just one small problem with all this: the facts don't back it up. Consider, for openers, the figures we got last week for "state final demand" (an imperfect interim substitute for gross state product).

Growth in this measure over the year to December averaged 2.7 per cent across Australia, but varied from 4.3 per cent to 1.5 per cent. The three fastest growing areas were the Northern Territory, the ACT and Tasmania.

Western Australia came fourth on 3.1 per cent and Queensland came eighth and last on 1.5 per cent.

As Saul Eslake of the Grattan Institute has reminded us, it's not arithmetically possible for all the states to be above average like the kids in Garrison Keillor's Lake Wobegon. There'll always be some above the average and some below it. There'll always be a multitude of reasons why, at any moment, some states are doing relatively well and others relatively badly.

Eslake has had a good look at the figures and found that, in the past two decades, there's never been a gap of less than 2 percentage points between the annual rates of growth in gross state product of the fastest and slowest growing states and territories.

But that gap is narrower in recent years than it used to be. Over the past five years it's averaged 3.7 percentage points, which is 1.5 percentage points narrower than it averaged over the previous 15 years.

Eslake adds that there's much less divergence in the performance of our states and territories than there is in comparable federations. Over the past four years our divergence has been half what it is for the American states and about a third of what it is for Canada's provinces.

But now Kieran Davies and Felicity Emmett, of the Royal Bank of Scotland, have examined the two-speed economy proposition using labour market figures for almost 70 regions around the nation.

In particular, they test the contention that the resources boom and the high dollar that goes with it are making the economy too dependent on mining and hollowing out the rest of the economy, thus making us more vulnerable to external shocks.

They find that at the height of the first stage of the resources boom in 2008, when national unemployment fell just below 4 per cent, unemployment was low across the country. There was a gap of only about 6 percentage points between the lowest regional unemployment rate of 2 per cent and the highest of 8 per cent.

Then, at the time when the mild recession caused by the global financial crisis led to national unemployment peaking at close to 6 per cent, the gap between the lowest regional unemployment rate of 1 per cent and the highest regional rate of 20 per cent was a massive 19 percentage points.

But now, as unemployment has continued to fall back from that peak, the gap has narrowed sharply. At the start of this year it stood at 14 percentage points, with the lowest regional unemployment rate still at 1 per cent and the highest falling to 15 per cent.

And get this: many of the regions with the lowest unemployment rates are in the non-resource-rich states. The regions with rates between 1 per cent and 2 per cent are in NSW (the Hunter Valley excluding Newcastle, and some parts of Sydney) and the Northern Territory. WA doesn't feature in the top 10, though rural WA comes in at No. 13.

In 2008, before the onset of the crisis, more than 90 per cent of the regions had unemployment of 6 per cent or less. Now, with the economy yet to return to that height, 70 per cent of regions are at 6 per cent or less. If that doesn't prove the benefits of the resources boom are being spread right around the economy, nothing will.

It's true the retailers are doing it tough at present (mainly for reasons that have little to do with the resources boom), but it's just sloppy thinking to see this as more evidence of the two-speed economy.

Why is it not a two-speed economy? Because about three-quarters of us work in industries that are neither great direct beneficiaries of the resources boom, nor great victims of the high exchange rate it has brought about.

And also because we live in one national economy, not eight isolated economies. There is a high degree of trade between the states and territories. They are subject to the same exchange rate, interest rate and federal budgetary policy.

A fair bit of the cream from the resources boom goes to the federal government. And all the mining royalties gained by the WA and Queensland governments are shared with the other state and territory governments via the formula by which the proceeds from the goods and services tax are divided between them.

The rise in the dollar is actually one mechanism by which part of the earnings of the miners is redistributed to all other industries and all consumers, in the form of cheaper imports.

If you think you've got nothing to show for the resources boom, all you're showing is your economic ignorance.


Saturday, March 5, 2011

Glimmering lights help dispel the gloom and doom

Peering through the statistical mist, the national accounts we saw this week tell us that, contrary to some messages we have been getting, the economy is on track and growing quite strongly. For the foreseeable future, growth will be coming more from business investment spending than from consumption.

Bureau of Statistics figures show real gross domestic product grew by 0.7 per cent in the December quarter. But Treasury estimates that the early days of the Queensland floods cut production, mainly coal production, by about 0.4 percentage points during the quarter.

So the ''underlying'' growth in GDP was probably nearer 1.1 per cent. If we take the actual growth over the year to December of 2.7 per cent and add back the 0.4 percentage points, we get underlying growth for the year of 3.1 per cent.

(Why is it OK to keep adding back the effect of the floods? Because the loss of production is expected to be temporary. After the full effect of the disruption is felt in the present quarter - maybe reducing GDP by a further 1 percentage point - growth will be higher than otherwise as the miners catch up and much money is spent repairing and replacing damaged homes, businesses and public infrastructure. The authorities expect the floods' effect on GDP to have largely been offset by the end of this year.)

The figures for growth in the December quarter continue the recent pattern of very strong growth in one quarter followed by a quarter of very weak growth and then back to strong growth again.

So let's abstract from the volatility by focusing on the figures for the year to December. They show consumer spending growing by 2.8 per cent - below the trend rate of growth, but not by a lot.

If that's stronger than you were expecting, the reason is that, yet again, the monthly figures for retail sales have proved an unreliable guide to the quarterly figures for total household consumption (which is more comprehensive). In real terms, retail sales grew by only 1.1 per cent over the year to December.

The sub-par growth in consumer spending is not the product of any weakness in the growth of household disposable income. It rose by 6.4 per cent in nominal terms.

No, consumer spending is moderate because households are saving more of their incomes, to pay down debt rather than add to it. The household saving rate averaged more than 9 per cent over the year to December, much higher than it's been for ages.

Spending on new homes and renovations grew by a weak 2.2 per cent over the year, which means we are not building enough homes to accommodate the growth in the population. Taken by itself, this puts pressure on house prices and rents.

Turning to business investment, spending on new machinery and equipment fell by 8.2 per cent over the year. That's probably because a lot of businesses brought forward purchases they would have made this year to take advantage of a tax break that was part of Kevin Rudd's stimulus package.

But spending on new equipment actually grew by 4.7 per cent in the December quarter, which suggest the hiatus may now be over.

The other major component of business investment is ''non-dwelling construction'' - the building of office blocks, shopping centres and mines. It has not been doing too well lately, with the exception of ''engineering construction'', which is mainly the mines.

New engineering construction grew by a massive 12.4 per cent over the year to December. And we know from what businesses have told the Bureau of Statistics about their intentions that there's a lot more spending to come this year and next.

Over the year to December, the volume (quantity) of our exports increased by 5.1 per cent, but the volume of imports increased by 8.4 per cent, with the effect that ''net exports'' (exports minus imports) subtracted 0.7 percentage points from the overall growth in GDP.

Turning from export and import volumes to export and import prices, our terms of trade - export prices relative to import prices - improved a little further in the December quarter, to be 22 per cent better over the whole year.

An improvement in our terms of trade makes us richer. This explains why our real gross domestic income rose by 7.7 per cent over the year, compared with the rise in real gross domestic product of 2.7 per cent. As this extra income is spent in coming months, GDP will accelerate.

Because they're so volatile, it's always good to cross-check the quarterly national accounts by comparing them with what we know is happening in the labour market. Over the year to January, total employment grew by a rapid 3 per cent, with 80 per cent of the 330,000 jobs created being full-time. Unemployment fell by 0.3 percentage points to 5 per cent.

This is a healthy economy notwithstanding the caution consumers are showing and the temporary effects of floods and cyclones. The strength is coming from investment in the expansion of our mining industry, and there's a lot more of it to come.


Wednesday, March 2, 2011

Bitter pill when politicians swallow big pharma's spin

Politicians always profess great sympathy for people struggling to keep up with the cost of living but often fail to put that sympathy into practice. Economists like to divide the economy into consumers on one side and producers on the other. They believe the economy should be run for the benefit of consumers, not producers. The consumer is supposed to be king.

Ostensibly, pollies think the same. But they're always doing deals with producers that allow them to charge higher prices at their customers' expense.

Why would politicians do such a thing? Because the producers are usually better organised. They have more to gain from a higher price - or lose from a lower price - than individual consumers have to lose or gain. Consumers are amateurs; producers are professionals and they put a lot of effort into lobbying governments.

But there's another factor. Every voter with a job is a producer as well as a consumer. Politicians care about jobs. And when producers offer to create new jobs - or, more likely, threaten to sack workers if they don't get what they want - the pollies usually play ball. They're easily conned.

Consider the case of pharmaceuticals. When a drug company - usually a big American or European corporation - discovers and develops a new medicine, it is granted a patent that amounts to a 20-year monopoly on the production of the medicine. If the medicine is highly effective, the monopoly allows the company to charge a very high price.

The standard justification for patents is that, by holding off competitors, they allow the company a period of grace in which to recover its research and development costs and make a big profit, thus encouraging more invention, to the benefit of society.

This explains why pharmaceuticals are so expensive in the United States. But the companies are prevented from charging such high prices in Australia by the operation of our pharmaceutical benefits scheme.

Under the scheme most drugs are, in effect, bought by the federal government, then sold to patients at heavily subsidised prices. This makes the government a "monopsonist" - a single buyer - and so gives it the ability to beat down the prices the drug companies are able to charge.

This explains why patented pharmaceuticals are so much cheaper in places such as Australia and Canada than they are in the US. The Aussie taxpayer benefits, as does the patient required to pay a smaller out-of-pocket contribution towards the cost of the drug.

Great stuff. But here's where the story gets bad. When a drug's patent expires, any drug company is allowed to start producing that drug in competition with the former patent holder. They can't appropriate the drug's trade name, of course, so they're known as generics. Generics are tightly regulated to ensure they're just as effective as the drug being copied.

So when a drug comes off patent and a lot of cheaper generics come onto the market, you'd expect the price of the trade-name drug to fall sharply. That's what happens in the US and in many other countries, but not in Australia. Why not? Because our pharmaceutical benefits scheme goes easy on the former patent holders. It drops the price by a bit, not a lot.

And it leaves it up to the prescribing doctor - and sometimes the patient talking to the chemist - to say whether a generic may be substituted. Many doctors and patients have an irrational attachment to the brand name, even though it's a lot dearer.

Last year the Rudd government proudly announced it had cut a new and tougher deal with the drug companies, represented by Medicines Australia, which would save the taxpayer $1.9 billion over five years.

The patents of a lot of expensive drugs will expire in the next few years. The deal involved cutting the prices of these drugs by 16 per cent and cutting the prices of generic drugs by 2 or 5 per cent from the start of this year.

But a health economist at the University of Sydney, associate professor Philip Clarke, and his colleague Edmund Fitzgerald, argue the deal still leaves our off-patent and generic drug prices much higher than they are in most developed countries. They quote the example of statins, the cholesterol-lowering drugs, where the patents of the various types have expired or soon will. Statins account for about 16 per cent of the total cost of the pharmaceutical benefits scheme.

They surveyed the wholesale price of Simvastatin 40mg in 10 developed countries and found our price was the highest: 50 per cent more than the next highest country and more than four times greater than the average price.

The lowest price was in New Zealand, which stages competitive tenders between the drug companies. Its price is just a fraction of our wholesale price of $1 a tablet. And even in the US, chains such as Kmart Pharmacy sell that statin for $15 for 90 tablets.

Clarke and Fitzgerald estimate that, compared with prices in England and Canada, the Rudd government's deal with the industry lobby will cost taxpayers and consumers $1.7 billion more over its five-year term. And that's just for the statin group of drugs.

The saving would be even greater, no doubt, if the government were game to take a firmer line on the prescribing habits of doctors.

Why would a government that professes to care so much about our cost of living cut such an expensive deal with the drug producers? Because, in practice, it gives a higher priority to maintaining an industry that makes the actual pills in Australia.

And the largely foreign-owned drug companies have conned it into believing that, unless it forces Australian consumers to paying much higher prices for off-patent drugs than people in other countries pay, the local industry will curl up and die.