Monday, October 17, 2011

Brave economist blows whistle on bosses' pay

You could be forgiven for not knowing it, but economists are meant to be tough on business. Their ideology holds that capitalism is good not because it's good for capitalists, but because it's good for consumers - and consumption is "the sole end and purpose of all production".

So said Adam Smith, who added that "the welfare of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer".

The economists' ideology holds that, when markets are working properly, most of the benefit flows to consumers in the form of lower prices and better service, with businesses making no more that "normal" profits (the lowest rate of profit needed to keep the firm's resources employed in its present industry).

Economists should also distinguish between the capitalists (the suppliers of capital - the shareholders) and the managers, who are supposed to be merely the agents of the shareholders who must at all times represent the true interests of the shareholders, never their own interests. Likewise, company directors are supposed to represent the shareholders' interests, not management's interests.

So economists are supposed to be pro-market, not pro-business and certainly not pro-management.

That's how it's supposed to be, but often not the way it is. In practice, economists who work for business aren't free to criticise it in public. The same goes for those who work for conservative governments (or Labor governments anxious to keep on side with business). And few academic economists take an interest in such mundane issues.

But another factor that helps explain the gap between principle and practice is that the economists' basic model recognises no role for collective action, including action by governments. So when things go wrong in markets, economists' first inclination is to defend the market and blame governments.

All this explains why economists have such a poor record in speaking out about excessive executive remuneration - as witness, the Productivity Commission's report on the subject of a few years back. That this is a case of market failure is as plain as a pikestaff, but the commission's economists searched under every rock without finding it.

One honourable exception to this glaring dereliction, however, is Diane Coyle, who tells it as it is in her latest book, The Economics of Enough. As her previous bestsellers attest, Dr Coyle - whose PhD is from Harvard - is a most orthodox economist.

Seeking to explain the origins of the explosion in executive pay, she attributes it to the deregulation of the financial markets in the US, Britain and elsewhere.

"Organised crime aside," she says, "the most ostentatious flaunting of wealth has emanated from the banking sector. As it turns out, these vast earnings and bonuses were undeserved. The bankers [in the US and Britain] ran up large losses, ruined their shareholders, and left taxpayers with the bill. It will be extraordinary if they turn out to have fooled, scared or bullied politicians around the world into stepping back from fundamental reform of the banking sector."

But the key point is the impact such high incomes in banking have had on the rest of society.

"The bonuses far in excess of salaries, and the spending on big houses, fast cars and designer clothes they funded, did create a climate of greed," she says.

"People in other professions who are in reality in the top 1 per cent or even 0.1 per cent of the income distribution were made to feel poor by the bankers.

"Banking bonus culture validated making a lot of money as a life and career goal. It made executives working in other jobs, including not only big corporations but the public sector too, believe that they deserved bonuses.

"Remuneration consultants, a small parasitic group providing a fig leaf justification for high salaries, helped ratchet up the pay and bonus levels throughout the economy.

"The whole merry-go-round of bonuses and performance-related pay is a sham. In almost every occupation and organisation it is almost impossible to identify the contribution made by any individual to profits and performance - complicated modern organisations all depend on teamwork and collective contributions."

So what can be done about it? In late 2009, the British government introduced a penal tax on bonuses above #25,000 in banking. The tax was criticised, not only by bankers but also by others who thought the measure impractical.

"But it was one of the few measures any government has so far taken that was absolutely right. The symbolism is vital even if by itself the measure doesn't bring to an end the corrosive culture of greed. Whatever the practical limitations on their actions, governments can still achieve a lot in symbolic terms, which should never be underestimated when it comes to impact."

And governments could do a lot more to change the social norms that helped destroy the Western financial system. For example, they could halt bonus payments in the public sector altogether, or introduce a general additional tax on non-fixed parts of people's pay packages.

"I am not opposed to people making more money if they studied hard or worked hard for it, or took the risk of setting up a successful new business - on the contrary, effort and entrepreneurship must be rewarded amply," Coyle says.

"Nevertheless, governments have to give a lead in restoring the sense of moral propriety and social connection between those people who are part of the extraordinarily wealthy global elite and the great majority of those with whom they share their own nation.

"Senior bankers should also contribute to this task of making greed and excess socially unacceptable once again." Amen to that.


Saturday, October 15, 2011

Understanding the Aussie dollar

Economic theory tells us the level of the exchange rate is an important factor in the health of the economy. Unfortunately, there's nothing in economic theory that can explain the Aussie dollar's strange behaviour in recent weeks. It's hard to know whether to cheer or boo.

We do know the Aussie has a strong and longstanding tendency to move in line with the prices we're getting for our commodity exports so, since during the past few years the prices of coal and iron ore have moved to record highs, it hasn't been surprising to see the Aussie rising to heights not seen since before it was floated in 1983.

It hit a peak of 110 US cents in early August, but seemed to settle at about 105 US cents. But in late September, during a bout of considerable anxiety on world markets about the state of the North Atlantic economies, it fell below parity, eventually getting down as low as 95 US cents.

But then this week it began going back up, reaching comfortably above parity, jumping 3 US cents in just 12 hours on Wednesday.

It's possible we've reverted to an earlier pattern where, when the global financial markets get particularly anxious about economic prospects, investors liquidate their short-term investments offshore and bring their money home to the safe haven of investment in government bonds. So the dollar appreciates (rises in value) and most other currencies depreciate (fall in value). Remarkably, this knee-jerk reaction can occur even when uncertainty about the fate of the economy is a major part of the anxiety.

That's step 1. Step 2 is for investors to calm down and start moving their money back overseas to destinations such as Australia in pursuit of higher returns than offered by bonds. If so, maybe that's what happened this week.

And if that's so, maybe step 2 has merely taken us back to square 1 - a dollar that settles well above parity. But who could be sure US cents Who knows what will happen the next time something really scary happens in Europe or the US cents Will the Aussie drop to, and stay at, a new level significantly below the 105 US cents it seemed to have settled at, or will it just go through a period of high volatility without actually changing its general level US cents

A point to note is that, though the media and markets' focus is always on our exchange rate with the greenback, economics teaches that what matters to the economy is our exchange rate with all our trading partners, not just the Americans.

Say you were taking a holiday in Britain. What would matter to you is our exchange rate with the pound. If you were going to Japan, it would be our exchange rate with the yen. In neither case would you regard our exchange rate against the greenback as particularly relevant.

It's the same story when Australian firms trade with Britain or Japan. Even if the price happens to be set in dollars - as it often is - the Aussie firm will translate that price into Aussie dollars, while the British or Japanese firm will translate it into their own currency.

Put the two together and what matters for the transaction is the Aussie-pound or Aussie-yen exchange rate. So we should be interested in our exchange rate with each of the countries with which we trade. And how much each bilateral exchange rate matters to us depends on how much trade we do with the particular country.

See where this is leading US cents The exchange rate that matters to the economy overall is the average exchange rate for all our trading partners, with each country's currency weighted according to its share of our two-way trade. Economists call this our ''effective'' exchange rate, which is represented by the trade-weighted index.

When you look at what's happened to our exchange rate against that index, you find the volatility in recent weeks is less. While we've depreciated against the greenback, we've appreciated against the euro and the Korean won.

There's always a lot of focus on what's happening to interest rates because we all know how important the rate of interest is to the strength of the economy. A rise in rates will slow economic growth by discouraging borrowing and spending; a fall in rates will hasten growth by encouraging borrowing and spending.

What's less well recognised is that the level of the exchange rate also affects the strength of the economy. So much so that the Reserve Bank brackets the two - interest rate and exchange rate - as ''monetary conditions''. When the exchange rate appreciates, this tends to slow the economy by reducing the price-competitiveness of exports and those domestically produced goods that compete against the now-cheaper imports in our domestic market.

It doesn't have much effect on domestic demand (our spending), but it does slow the growth of aggregate demand (our production - gross domestic product, in fact) by reducing exports and by diverting more of our spending into imports.

Conversely, when the exchange rate depreciates, this tends to speed the economy by improving the price-competitiveness of our export and import-competing industries. Domestic demand isn't much affected, but GDP improves because we export more, and more of our spending goes on domestically produced goods and services rather than imports.

This, of course, is why our manufacturers have been doing it tough under the high exchange rate. They've found it harder to export and to compete against imports. Though it's received far less public sympathy, our tourist industry has suffered in the same way, with fewer foreigners coming to Australia and more Aussies holidaying abroad rather than locally.

Our universities and other education exporters have been hit also.

So I'm quite sorry to see the dollar going back up this week after having fallen by up to 10 per cent from its heights. It would have been great to take a bit of the pressure off the manufacturers, tourist operators and education exporters.

The econocrats have a rule of thumb saying a sustained fall in the exchange rate of 10 per cent should lead to a rise in real GDP of about 0.75 percentage points over the following two years - say, 0.4 points in each year. (The rule also holds for a rise in the exchange rate causing slower GDP growth.)

So whereas a lasting fall in the Aussie might have been bad news for motorists (price of petrol) and people planning overseas trips, it would have helped make our multi-speed economy a little less uneven.


Wednesday, October 12, 2011

Look within to pick up productivity

One of the tricks to success - in business, or in life - is to focus on the things that matter, not the things people (and hence, the media) are getting excited about this week. Of late we seem to be doing a lot of worrying about the wrong things.

For instance, our preference for bad news over good means we've been doing a lot of hand-wringing over the economic problems in Europe and the US. What's happening in China and the rest of developing Asia may be far less worrying - and hence, less interesting - but it's also far more important to the fate of our economy.

When we look at our economy, we give much more attention to the alleged two-speed economy - who's feeling hard done-by this week? - than to the truth that, with limited exceptions, the economy has been travelling well, is travelling well and is likely to continue travelling well.

As part of this, of late we've been devoting inordinate attention to the problems of the manufacturing sector (which accounts for 9 per cent of total employment), without any concern for the services sector (accounting for a mere 85 per cent of employment), even though two big service industries - tourism and education - have also been hard hit by the high dollar.

But even those of us happy to acknowledge how well our economy's travelling, thanks to high export prices and the mining construction boom, are less conscious of the sad truth that, underneath all that, the economy's productivity - output per unit of input - has stopped improving.

We're getting richer because the world is paying us a lot more for our exports and is engaged in a massive expansion of our mining industry, not because our businesses are getting more efficient at what they do.

That message is, however, getting through to big business and its various lobby groups. Only trouble is, in their search for a solution to the productivity problem they've been looking outside their firms, not inside. Perhaps if the government reformed the tax system, that would lift productivity. Or maybe going back to Work Choices would help.

It's possible that, while they come to our attention only when they're putting their oar into the public debate, most chief executives are busily engaged attending to their own, internal affairs. It's possible, but there doesn't seem much evidence of it.

That's why the most useful thing to come from last week's jobs forum in Canberra was the unveiling of a study on the leadership, culture and management practices of high-performing workplaces, sponsored by the Society for Knowledge Economics with funding from the federal government.

A team of academics from the University of NSW, the Australian National University, Macquarie University and the Copenhagen Business School examined 77 businesses in the services sector with more than 5600 employees. Most were medium size, and included law and accounting firms, advertising companies, consulting firms and employment agencies.

It's probably the most comprehensive study of workplace performance undertaken in Australia in the past 15 years. The performance of businesses was measured in six categories: profitability and productivity, innovation, employee emotions, fairness, leadership and customer orientation.

The study identified 12 high-performing workplaces and 13 low-performing workplaces, leaving most of the firms studied somewhere in the middle. So what are the characteristics of high-performing workplaces and how much better are they than the low-performing?

Well, not surprisingly, the best performers were more profitable and productive. According to the lead researcher, Dr Christina Boedker, high-performing workplaces are up to 12 per cent more productive and three times more profitable.

And it's not too surprising the best performers are better at innovation. They generate more new ideas and are better at capturing and assessing their employees' ideas. In consequence, they make more improvements to services and products, production processes, management structures and marketing methods.

But some treat-'em-mean-to-keep-'em-keen managers will be surprised that high-performing outfits do better on employee emotions. They have higher levels of job satisfaction, employee commitment and willingness to exert extra effort, and lower levels of anxiety, fear, depression and feelings of inadequacy. Part of the bottom-line consequence of this is lower rates of staff turnover.

The employees of high-performing firms tend to be more satisfied people, are being paid fairly and company policies are being implemented fairly.

High-performing firms rate better on customer experience. They try harder to understand customer needs, are better at acting on customer feedback and better at achieving their own goals for customer satisfaction.

But the study is particularly concerned with the performance and attitudes of managers, which business-types these days put under the heading of ''leadership''. In high-performing outfits, managers and supervisors devote more time to managing their people, have clear values and practise what they preach.

They welcome criticism as a learning opportunity. They foster involvement and co-operation among staff, give them opportunities to lead activities, encourage development and learning, give them recognition and acknowledgement and encourage them to think about problems in new ways.

The management practices that do best, according to the study, are being highly responsive to changes in customers' and suppliers' circumstances, encouraging high employee participation in decision-making, achieving on-the-job learning through mentoring and job rotation, making effective use of information and technology and attracting and retaining high quality people.

Of course, different managers have different cultures or styles. Some emphasise results, some their people and some coping with change. The study finds all three approaches can make a high-performance workplace. The one style that doesn't work is the ''control'' culture.

Wow. How'd you like to work for such a boss in such an enlightened business? Pity is, such firms accounted for only 15 per cent of the sample.


Monday, October 10, 2011

Taxation reform is a cargo cult for business

When you look at the varied contributions to the public policy debate made by business people and their lobby groups, one attitude unites them: the politicians owe them a living.

Government, it seems, has one overwhelming responsibility: to make life easier for business. You see this in business people's views on "competitiveness". Economics has a lot to say about competitiveness, but not what business people imagine it says.

To them, competitiveness refers to the ability of Australian firms to compete in international markets against the enemy, firms from other countries. It's a zero-sum game, apparently: either we win and they lose, or they win and we lose.

Hence our government's obligation to improve our team's competitiveness by cutting the taxes Australian firms have to pay or by weakening the bargaining power of employees and so cutting our firms' labour costs.

What economics actually says is, first, trade is a positive-sum game: both countries win by exploiting the "gains from trade". Second, competitiveness isn't a gift governments confer on their businesses, it's a stricture they impose as the best way of ensuring firms aren't able to make excessive ("super normal") profits at the expense of the intended beneficiaries of competitiveness, Aussie consumers.

Most of the micro-economic reform project was aimed at increasing competitiveness by making life tougher for business: by reducing protection against competition from imports (the exports of our supposed enemies), by removing regulations that inhibited competition between local firms, and by beefing up prohibitions on anti-competitive practices.

We know micro reform failed to achieve a lasting increase in the rate of productivity improvement. Its lasting benefit has been to make the economy more flexible and resilient in response to economic shocks.

In particular, by increasing the intensity of competition in so many markets it has robbed many businesses of their former pricing power - including their ability to conclude sweetheart deals with their unions - and made our economy markedly less inflation-prone.

So much for the happy notion micro reform involves governments making life easier for business.

Further evidence of business's cargo-cult attitude to the role of government can be seen in its approach to tax reform. Business has an insatiable obsession with taxation. It wouldn't matter how much reform we'd achieved, its demands for more reform would be undiminished. That's because it's convinced the less tax it has to pay the easier its life will be.

There's a large element of self-delusion in this. Neither business people nor punters genuinely understand that, in the final analysis, companies - being inanimate objects - don't bear any tax burden. In the end, only humans pay tax - whether they're the owners, the managers, the employees or the customers of the company.

Just how the ultimate burden of all the various taxes companies pay is shared between those groups does matter, of course, but that's a complex empirical question with uncertain answers. And it's a safe bet all the sparring over company tax at last week's tax forum was motivated more by perceptions and appearances than empirical realities.

The key reform demanded at the forum, pushed hard by the Business Council, was for the rate of company tax to be cut from 30 to 25 per cent, with the cost to be covered by an increase in the GST.

Don't like the sound of that one? Neither did the union reps. But, cried the business people and the tax economists, didn't you know empirical studies show the ultimate "incidence" of company tax falls largely on labour? Since much the same is true of the GST, what rational reason could unions have to object to such a neutral rebalancing of the tax mix? But that question cuts both ways. If the ultimate incidence of company tax is borne by labour, why are company executives so desperately keen to get its rate reduced? (And how do the tax economists explain why such a shifting of the furniture would be so clearly beneficial for the economy overall?)

A point rarely mentioned is that the existence of dividend imputation means the local shareholders of companies have nothing to gain. For them, a lower company tax rate just means smaller franking credits. And that being the case, exactly why does big business imagine a lower company tax rate would be such a benefit? Perhaps because many, maybe most, of the chief executives who make up the Business Council actually represent the interests of foreign shareholders, who aren't subject to the imputation system.

For further evidence of business's cargo-cult mentality, consider what I call the "leadership theory of tax reform", so much in evidence at the forum. Consider the air of righteous disappointment exhibited by business leaders and commentators when Julia Gillard failed to meet the Business Council's demand that she commit to a 10-year program of tax reform.

Oh, if only the government would exhibit some Leadership, they cried. Come again? This government is already knee-deep in unfinished tax reform, all with no active support from business (the deeply divided Business Council) and much active opposition (the business coalition running TV ads against the carbon tax).

This is even though some businesses urged the reform on the government (we want certainty on the price of carbon) and many parts of business stand to gain from the mining tax (20 per cent of the desired cut in the company tax rate, concessions to small business and a one-third increase in the captive market compulsory super delivers to the financial services industry).

All the righteous calls for politicians to show Leadership on tax reform come without the slightest commitment that business will back up the leader when the going gets tough. Dream on, guys.


Saturday, October 8, 2011

Doomsday rate cut scenarios off mark

If the Reserve Bank ends up cutting the official interest rate by 0.25 percentage points on Melbourne Cup Day, it won't be because the economy has weakened so much as because it's not looking as strong - and thus, inflationary - as the Reserve had earlier expected.

The air is full of uncertainty and fear about the fate of the European and American economies, with one excitable pundit even predicting a ''world recession''. But, short of a major meltdown, the North Atlantic countries' troubles won't be a big part of the Reserve's reasons for fine-tuning the stance of its monetary (interest rate) policy.

No one knows what the future holds, and there's a ''non-trivial probability'', as the economists say, that the US economy will start contracting again and, more significantly, the problems in Greece will be so badly handled that the European economies implode.

Were that to happen, be in no doubt: the Reserve wouldn't just be lowering rates by one or two clicks, it would be slashing rates in much the way it did in the global financial crisis of 2008-09. But that's far from the authorities' ''central forecast''. They expect the US to grow by a bit under 2 per cent next year, while the euro area achieves no growth.

What would plunge Europe and the world back into crisis - with Europe entering a period of severe contraction - would be for Greece to leave the euro. That's because of the panic this would cause to euro depositors in many other member-countries.

It's likely the Europeans well understand what they need to do to avoid a conflagration: first, restructure the Greek government's debt (which means bond holders accepting big write-downs); second, recapitalise those European banks hard-hit by the write-down; third, have the European Central Bank purchase large quantities of European governments' bonds so as to lower bond yields and, hence, commercial interest rates.

So the Europeans' problem isn't knowing what to do, it's achieving the agreement of 17 squabbling member-countries to do it. The likeliest outcome is that they do enough to avert catastrophe, but not enough to prevent recurring episodes of financial-market jitters.

Our authorities' forecasts for 2012 aren't far from those the International Monetary Fund published last month. These have the US growing by 1.8 per cent and the euro area by 1.1 per cent. If so, that leaves the world economy growing by, what - 1.5 per cent? No, by 4 per cent - which is about the trend rate of growth. Huh?

What's missing from the sum is China's growth, expected to slow to a mere 9 per cent, and India's, to a paltry 7.5 per cent. Even Latin America is expected to grow by 4 per cent and sub-Saharan Africa by 5.8 per cent.

So much for a world recession.

Weakness in the North Atlantic doesn't equal weakness in Australia by a process of magic. You have to trace linkages between them and us. An important one is psychological: the effect of a sliding sharemarket, worrying news from the North Atlantic and over-excited talk of world recessions on the confidence of Australian consumers and business people.

As for ''real'' (tangible) linkages, these days the US and Europe aren't big export customers of ours. So the key question is the extent to which weakness in the North Atlantic leads to weakness in China, India and the rest of developing Asia.

These days, China is a lot less dependent on exports to the North Atlantic than it used to be. And the Chinese authorities have both the political imperative and the economic instruments needed to keep domestic demand growing fast enough to prevent much of a slowdown in production and employment growth.

So, barring a European implosion, the North Atlantic troubles' effect on us is likely to be limited mainly to their effect on confidence. If so, what are the domestic factors that could lead the Reserve to lower interest rates a little?

In May the Reserve was forecasting growth in 2011 of 4.25 per cent. In August it cut that to 3.25 per cent. Today it would probably say 3 per cent.

But get this: the overwhelming reason for these revisions is the temporary effect of the Queensland floods, in particular the loss of output from coalmines that are taking far longer than expected to resume production.

There have been various highly publicised areas of weakness in the domestic economy - the troubles our manufacturers are having coping with a high exchange rate, very weak department store sales and weak housing starts - but overall (and excluding extreme weather events), there's little sign of weakness.

Despite the much-publicised fall in

consumer confidence, consumer spending grew by 3.2 per cent over the year to June, bang on trend. Business investment has been strong and is sure to get stronger. And earlier figures showed worsening inflation and worryingly strong growth in labour costs per unit of production.

Indicators released this week show strong growth in exports and strengthening retail sales, home building approvals and non-residential building approvals.

The strongest evidence of weakening is in the labour market, with employment growth clearly slowing from its earlier fast past, and the unemployment rate jumping 0.4 percentage points to 5.3 per cent in just two months.

But this is a puzzle because, though growth in employment is weak, growth in hours worked isn't. And though surveyed unemployment is supposed to have jumped, the number of people on the dole is steady.

So how does the Reserve come to be contemplating lowering the official interest rate a little? Because its job is to keep interest rates at a level sufficient to keep inflation travelling within its 2 to 3 per cent target range, and the outlook for inflation has become less threatening.

For a start, the Bureau of Statistics has revised the underlying inflation rate over the year to June from 2.75 per cent to 2.5 per cent. Second, the outlook for economic growth isn't quite as strong as it had been. And third, the atmospherics of the labour market have improved, with more consumers worried about losing their jobs and employers less worried about the emergence of excessive wage demands.

The present stance of monetary policy is ''mildly restrictive''. But if the risk of inflation rising above the target range is now much reduced, the stance of policy should be returned to neutral. That would require a fall in the official rate of just one click - two at most.


Wednesday, October 5, 2011

Tax cut buffet but no appetite for fixes

Seen anything on the tax reform smorgasbord you fancy? How about cuts in the top two rates of income tax? How about abolition of conveyancing duty? Or maybe an end to stamp duty on insurance policies?

For business people there's a special range of goodies on display: a cut in the company tax rate to 25 per cent, special tax breaks for mining and construction companies that use Australian steel, abolition of payroll tax. Or maybe cuts in company tax that are limited to small businesses.

Don't see anything that particularly appeals? That's OK, why not concoct your own, custom-built concession? It's a bit late, but why not email it in as a submission to the tax forum? Be sure to say it will do wonders for the economy - which is why you're proposing it, naturally. I'm sure it will get as much consideration as all the other submissions.

Sorry, but the tax forum reminds me of nothing so much as a bunch of kiddies lining up to sit on Santa's knee and whisper into his ear what they'd like for Christmas. Dream on, kids. The harsh truth is that neither the federal nor the state governments are in any position to simply cut this tax or that. They're all struggling to get their budgets back to surplus.

So one of the ground rules Wayne Swan laid down was that all proposals for tax reform had to be "revenue neutral" - if you cut one tax you have to increase another by the same amount. You'd like to pay less income tax? No probs - we'll just increase the rate of the GST to cover it. Or maybe we could increase the rate and remove the exemptions for food, education and health care. That would make the GST a far more robust revenue-raiser.

Increase GST revenue far enough and we could also afford to abolish the payroll tax business keeps whingeing about. As for conveyancing duty, the ideal way to finance its abolition would be to broaden annual land tax to cover owner-occupied homes. Someone has suggested local government could be paid a fee to collect it along with council rates.

Kind of takes the fun out of tax reform, doesn't it?

Of course, were governments to get serious about reform there are a lot of other worthy but nasty things they could do. Bite the bullet and get rid of negative gearing, for instance. Stop family trusts being such a tax lurk. Crack down on the abuse of work-related deductions (especially by doctors and lawyers jetting off to conferences at exotic resorts).

Then there's superannuation. It's always been taxed heavily in favour of high income-earners, but Peter Costello's decision to make all private pension income tax-free to people 60 and over was the ultimate in favouring wrinklies over workers.

I should tell you the latest fashion among tax-reform aficionados is for income (particularly high incomes) and capital (particularly companies and capital gains) to be taxed more lightly, with consumption and real estate taxed more heavily.

This is because financial capital and high income earners are more mobile internationally - more capable of moving to countries where they're taxed more lightly - whereas wage-slaves and consumers are far less mobile and real estate is utterly immobile.

So, in an era of growing tax competition between countries, you tax those who can't escape more heavily and those who can escape less heavily. That this means the well-off pay less tax while the middle class and the workers pay more is purely coincidental, I assure you.

If you're detecting a touch of cynicism in my reaction to all this, you're not wrong. Economists, business people and professional lobbyists would happily meet in Parliament House once a month to preach to each other about the need for tax reform.

But if ever there was a country that runs a mile at the hint of tax reform, we're it. Most of the rest of the developed world introduced a GST in the 1960s and '70s, but we trembled on the brink for 25 years before taking the plunge in 2000.

The way tax reform works in Australia is that whenever governments are persuaded to introduce some major reform, the opposition automatically opposes it and starts a hugely successful scare campaign, urged on by every adversely affected interest group, the shock jocks and any other media outlets looking for cheap cheers.

Meanwhile, the people who'd benefit from the reform - even those who pressed the government to take it on - fall silent or, like the Business Council, get cold feet and run around saying the time is not yet ripe. All the academic urgers peel off the moment the government introduces a less-than-pure element to its scheme.

The obvious truth is Julia Gillard would need her head examined to take on more tax reform at present. Her plate is already over-full. You'd never know it from all the chat this week, but we're already engaged in two vitally important tax reforms: the carbon tax and the mining tax. The first is complicated but minor in its effect on household budgets; the second is a no-brainer.

Yet Tony Abbott has been hugely successful in his dishonest scaremongering against both taxes. He is campaigning against all tax reform, promising to reverse both measures and pretending taxes only ever need to be cut. Are the Liberal-leaning reform advocates doing anything to set him straight? Hell no - that's Julia's lookout. And the polls say the man with the neanderthal views on tax reform will be swept into office at the first opportunity.

When it comes to tax reform, Australians are utterly lily-livered.


Monday, October 3, 2011

Two minds make us all muddled thinkers

Conventional economics got set in its ways long before neuroscientists discovered something that helps explain why the decisions consumers and business people make are often far from rational: our brains have two different, and sometimes competing, systems for deciding things.

Psychologists call it system one and system two thinking. System one is our intuitive system of processing information. It's fast, automatic, effortless, implicit and emotional. It's controlled by the earlier, more primitive part of our brain. It's highly efficient and is thus the most appropriate tool for the majority of mundane decisions we make every day.

By contrast, system two thinking is slower, conscious, effortful, explicit and more logical. It's controlled by the more recent, frontal part of our brain. When we weigh the costs and benefits of alternative courses of action in a systematic and organised manner, we're engaged in system two thinking.

In the hands of scholars who study behavioural ethics - such as Max Bazerman and Ann Tenbrunsel, the authors of Blind Spots - system one is seen as our "want-self" and system two as our "should-self". Almost all of us regard ourselves as ethical. Before decisions arise our should-selves think "I should behave ethically, therefore I will".

When we're looking back on decisions, our should-selves think: "I should have behaved ethically, therefore I did." Trouble is, when the decision is actually being made, our want-selves take over and we often do things that ignore the ethical implications of our actions.

The task for behavioural ethicists, therefore, is to help us find strategies that allow our should-selves to dominate our want-selves. In another context, psychologists say we have different systems for wanting things and liking things. So some of the stuff we really want, and spend a lot of time pursuing, doesn't give us as much satisfaction as we thought it would once we've got it.

This explains why children will spend weeks nagging parents to buy them a guitar or a pet but quickly lose interest once they have it.

It also explains a lot of futile adult behaviour. I suspect our two thinking systems explain the paradox of advertising. I'm not influenced by all the advertising I see, but a lot of people are. Do you think that, too? Trouble is, most people think it.

If it's true, just who are the dummies that fall for advertising? And how come so many businesses spend millions on advertising, convinced it's money well spent?

I think all of us are more susceptible to advertising than we realise. Most advertising is designed to appeal to our emotions and instincts, not our intellect. In other words, it's aimed at our unconscious, system one decision-maker and we're not conscious of the way it affects the choices we make. Meanwhile, our conscious, reasoning system two brain is unimpressed by the illogical connections we see in ads.

I'm sure they're not all Robinson Crusoe, but economists often show signs of having two-track minds. They believe certain things intellectually, but these beliefs don't seem to have the effect on their behaviour that you'd expect.

For instance, when you criticise their model for its absurd assumption that people are always rational - carefully calculating and self-interested - they'll tell you they don't actually believe people are rational; that's just a convenient assumption needed to get the model going.

But then they'll argue vigorously for propositions that come from the model, oblivious to the way those propositions rest on the assumption that people are indeed rational in all they decide.

Or, take the exaltation of gross domestic product. When you argue that GDP is a poor measure of national well-being and point out its various limitations, economists will agree. But that won't stop them continuing to treat GDP is though it's the one thing that matters.

One of the most ubiquitous problems in daily life - and thus in the economy - is one the economists' model assumes away: achieving self-control. We need to control our natural urges to eat too much, to smoke, to drink too much, to gamble too much, spend too much, watch too much television, get too little exercise and even to work too much.

Here, again, we seem to have two selves at work: an unconscious self that's emotional and shortsighted and a conscious self that's reasoning and farsighted. We have trouble controlling ourselves in circumstances where the benefits are immediate and certain, whereas the costs are longer-term and uncertain.

When you come home tired from work, for instance, the benefits of slumping in front of the telly are immediate, whereas the costs - feeling tired the next day; looking back on your life and realising you could have done a lot better if you'd got off your backside and played a bit of sport, sought a further qualification at tech, studied harder for exams, spent more time talking to your children, etc - are not so clear-cut.

Similarly, the reward from eating food is instant whereas the costs of overeating are uncertain and far off: being regarded as physically unattractive, becoming obese, becoming a diabetic, dying younger, etc.

As everyone who has tried to diet, give up smoking, control their drinking, save or get on top of their credit card debt knows, it's hard to achieve the self-control our conscious, future-selves want us to achieve.

People have developed many strategies to help their future-selves gain control over their immediate-selves, including pre-commitment devices - similar to those proposed by the Productivity Commission to assist problem gamblers.

Economics will become a more useful discipline when its practitioners catch up with developments in neuroscience and offer us solutions to common behaviour problems it now assumes away.


Saturday, October 1, 2011

You're not as ethical as you think

Another long weekend, another personal question: how honest are you? According to the people who study these things, not as much as you think you are.

In an experiment in which people were asked to solve puzzles and were paid a set amount for each puzzle they solved, some participants were told to check their answers against an answer sheet, count the number of questions answered correctly, put their answer form through a shredder, report the number of questions they got right to the experimenter and receive the money they had earned.

A second group wasn't allowed to shred their answers before reporting how many they got right. Those whose claims about how many they got right couldn't be checked claimed to have got significantly more correct than the second group.

Those who cheated probably counted a problem they would have answered correctly if only they hadn't made a careless mistake. Or they counted a problem they would have got right if only they'd had another 10 seconds.

In other words, they didn't tell blatant lies, they just gave themselves the benefit of any doubt, bent the rules a little bit in their own favour. And get this: they wouldn't have thought they were cheating.

When subjects are asked to rate how ethical they are compared with other people on a scale of 0-100, where 50 is average, the average rating is usually about 75. That is, almost all of us consider ourselves to be more ethical than other people.

Clearly, that's not possible. In their book, Blind Spots, Max Bazerman, a professor of business administration at Harvard Business School, and Ann Tenbrunsel, a professor of business ethics at the University of Notre Dame, say most of us behave ethically most of the time.

Even so, most of us overestimate our ethicality relative to others. We're unaware of the gap between how ethical we think we are and how ethical we actually are. We suffer from blind spots.

Bazerman and Tenbrunsel are exponents of the emerging field of ''behavioural ethics'' - the study of how people actually behave when confronted with ethical dilemmas. They say our ethical behaviour is often inconsistent and, at times, even hypocritical.

''People have the innate ability to maintain a belief while acting contrary to it,'' they say. ''Moral hypocrisy occurs when individuals' evaluations of their own moral transgressions differ substantially from their evaluations of the same transgressions committed by others.''

Hypocrisy is part of the human condition; we're all guilty of it. So you could say accusing someone else of being hypocritical is itself a hypocritical act.

Some people are consciously, deliberately unethical. But Bazerman and Tenbrunsel stress their interest is in unintentional ethical misbehaviour. How can we behave unethically and not realise it?

We suffer from ''bounded ethicality'' because we suffer from ''bounded awareness'' - the common tendency to exclude important and relevant information from our decisions by placing arbitrary and dysfunctional boundaries around our definition of a problem.

One way we limit our awareness is by making decisions on the basis of the information that's immediately available to us - maybe that someone has presented to us - rather than asking what information would be relevant to making the best decision, including other aspects of the situation and other people affected by it.

An organisation's ethical gap is more than just the sum of the ethical gaps of its individual employees, the authors say. Group work, the building block of organisations, creates additional ethical gaps.

Goupthink - the tendency for cohesive groups to avoid a realistic appraisal of alternative courses of action in favour of unanimity - can prevent groups from challenging questionable decisions.

And functional boundaries can prevent individuals from viewing a problem as an ethical one. Organisations often allocate different aspects of a decision to different parts of the organisation.

''As a result, the typical ethical dilemma tends to be viewed as an engineering, marketing or financial problem, even when the ethical relevance is obvious to other groups,'' the authors say. So everyone can avoid coming to grips with the ethical issue by assuming someone else is dealing with it.

Now consider this. You're a 55-year-old and have just been diagnosed with early-stage cancer. You consult a surgeon, who wants to operate to try to remove the cancer. You consult a radiologist who recommends blasting the cancer with radiation. You consult a homeopathic doctor who believes you should use less intrusive medicine and wait to see how the cancer develops.

Many of us would assume each specialist is lying so as to drum up business. But it's actually more complicated. Each person genuinely believes their treatment to be superior, but they fail to recognise their beliefs are biased in a self-serving manner.

They don't realise their training, incentives and preferences prevent them from offering objective advice. They just don't realise they're facing an ethical dilemma. They don't see they face a conflict of interest because they view conflicts of interest as problems of intentional corruption.

Bounded ethicality occurs because our cognitive limitations - the limitations of the way our brains work - leave us unaware of the moral implications of our decisions. Aspects of everyday work life - including goals, rewards, compliance systems and informal pressures - contribute to ''ethical fading,'' a process by which ethical dimensions are eliminated from a decision.

It's common for decisions at work to be classified as a ''business decision'' rather than an ''ethical decision,'' thus increasing the likelihood we will behave unethically.

Sometimes differences in language allow ethical fading. Albert Speer, one of Hitler's ministers and trusted advisers, admitted after the war that by labelling himself an ''administrator'' of Hitler's plan he convinced himself that issues relating to the treatment of people were not part of his job.

Why does the way we classify decisions matter? Because classification often affects the decisions that follow. When we fail to recognise a decision as an ethical one, whether due to our own cognitive limitations or because external forces cause ethical fading, this failure could well affect how we analyse the decision and steer us towards unintended, unethical behaviour.

Why do we predict we will behave one way and then behave another way, over and over throughout our lives? General principles and attitudes drive our predictions; we see the forest but not the trees. As the situation approaches, however, we begin to see the trees and the forest disappears.

Our behaviour is driven by details, not abstract principles.