Thursday, May 23, 2013


Keynote address to External Dispute Resolution forum, Sydney

Since Fiona Guthrie has billed me as talking about behavioural economics I want to talk about a subject of little interest to conventional economists: the sometimes yawning gap between the way we perceive the economy and our place in it and the way the objective indicators say it actually is and where they say we fit into it. I’ll do so with special reference to financial counsellors and the people they counsel.

I was to start by observing that the economy isn’t travelling too badly at present, but if you listen to what you hear from much of the media, you could be forgiven for thinking it’s in terrible shape. I can think of four reasons why the economy’s doing a lot better than many people imagine. First, a fair bit of it is political: if you don’t like the Gillard government it’s easy to conclude it must be making a mess of the economy. Second, the world economy is not growing strongly and a lot of the bad news we get from Europe may be worrying people, even though our strong and growing links with the developing Asian economies mean we are much less affected by problems in the North Atlantic economies than we used to be. Third, another part of the explanation may be that all the fuss about the Gillard government’s inability to keep its promise to return the budget to surplus this year may have been taken wrongly by some as proof it is managing the economy badly. But, fourth, it remains true that some parts of the economy are under great pressure from the high exchange rate and other factors and, as we’ll see, many people have a tendency to think that  if I’m doing it tough the whole economy must be stuffed.

When you stand back from all the argument and complaints, however, you see the economy isn’t doing too badly. It’s been growing at about its medium-term trend rate of 3 per cent a year, though the budget forecasts it will slow to a little below trend in the coming financial year. The rate of unemployment has been a bit above 5 per cent for the past few years - which is quite low by the standards of the past 30 years - though it’s now drifting up slowly and may reach 5.75 per cent by June next year. Inflation remains low at about 2.5 per cent and has stayed within the 2 to 3 per cent range for three years. The diminishing threat from inflation has allowed the Reserve Bank to cut the official cash rate to an exceptionally low 2.75 per cent (it was 7.25 per cent before the GFC), meaning mortgage interest rates are the lowest they’ve been since the time of the GFC.

I've been thinking a fair bit lately about differences in people’s perspectives and perceptions of the economy. Whereas economists form their views about the state of the economy using economy-wide statistics - meaning they view the economy from a helicopter, so to speak - most business people and ordinary citizens base their views on their own experience and the experience of those around them. What’s happening to me is what’s happening to the economy. If I’m a shopkeeper and my sales are down, it’s obvious the economy’s very weak. If I’m a worker but I haven’t been able to find a job for months, it’s obvious the economy’s stuffed.

The second, more ephemeral factor that influences the views of non-economists is what they see and hear from the media about the state of the economy. But apart from when it’s quoting the official statistics, most of what the media tell us is quite unrepresentative of what's happening to most people. Why? Because the media tell stories about the experiences of individuals, and the stories the media choose to tell are those they believe their audience will find interesting. But the stories we find most interesting are those that are unusual rather than usual, thus making them unrepresentative of the economy rather than representative. This explains the media’s overwhelming preference for bad news rather than good news: people find bad news far more interesting. So, for example, any factory that decides to lay off 350 people will hit the headlines, whereas a factory that took on 350 workers would hardly rate a mention.

Another thing to bear in mind is that, in general, the people to whom you provide financial counselling come from the opposite side of the tracks to the relatively well-off and well-educated readers I write for. I often take a fairly unsympathetic line to the complaints of the comfortably off precisely because I'm aware of the genuine, often extreme financial hardship suffered by people struggling to manage on very much lower incomes. But just as I try to remind my readers how comparatively well off they are, so you need to remember that the people you see are also unrepresentative of the wider economy. If one in five adult Australians experience financial stress each year, then four in five don’t experience stress to any great extent.

Dr Nicola Brackertz, of Swinburne University, has prepared a report for the Salvation Army (my co-religionists) that tells us a lot about the circumstances of people suffering genuine financial stress. She surveyed more than 200 of the clients of the Salvos’ free financial counselling service, Moneycare.

The first thing to note is that a third of respondents were living alone and another 28 per cent were sole parents. Only 14 per cent were couples with dependent children. Two-thirds of them were women. Almost 80 per cent had a government pension or benefit as their main source of income. Only 15 per cent had wages as their main income. Almost 40 per cent of respondents were renting privately and 22 per cent were renting public or community housing. Only 21 per cent were paying off a mortgage and just 5 per cent owned their homes outright.

Put all this together and it tells me we’re dealing with people right at the bottom of the heap. Most of the respondents would be unemployed, people on the disability support pension or sole parents (many of whom have been relegated to the dole by a grateful government). Since the great majority of age pensioners own their homes, we’re dealing in the main with only those age pensioners living alone and renting. It all goes to show how close people on the dole live to the poverty line, the more so if they have to rent privately.

With rents the way they are, it’s no surprise that people living in privately rented accommodation on a very low income are highly likely to experience financial stress. The surprise is the disproportionate number of respondents living in public housing. The rent these people pay is generally set at 25 per cent of their income, no matter how low their income is. That sounds pretty generous; the standard measure of housing stress is rent or mortgage payments exceeding 30 per cent of income. The trouble is that the cost of true necessities such has food, clothing and power tends to be a reasonably fixed amount, whatever your income. So if your income is very low, you may not be left with enough for spending 25 per cent of the total on rent to be easily manageable. By the same token, if your income is quite high, a lifestyle choice to devote a lot more than 30 per cent of it to housing doesn’t leave you feeling the pinch.

If you’re as comfortably off as I am, it’s a surprise to discover how small were the total debts that got the respondents into trouble with their creditors. Although a third had debts of more than $20,000, the typical (median) debt level was $5000 to $10,000. Almost half had three or more sources of debt, with the most common being utility bills, credit cards, phone bills and personal loans. Well over half the respondents had been experiencing financial difficulties for two years or more.

Why did the respondents get into financial trouble?  In their own words, ‘the leading causes were insufficient income caused by retrenchment, unemployment, underemployment and an insufficient level of government allowances and pensions,’ the report says. ‘Health reasons, including disability and mental illness, often prevented respondents from earning sufficient income.’

It’s easy for the comfortable to tell themselves these people are just bad money-managers. But American research I’ve been reading says they’re no better or worse managers than the rest of us. Their real problem is that life at the bottom so much more unforgiving. When your income’s so low you need all of it just to get by, there’s no scope to build a buffer of money to cover you when quarterly utility bills arrive or some unexpected expense arrives. And when you can’t afford comprehensive car insurance of home content insurance, big unexpected expenses are more likely to arrive. When some service is cut off because you haven’t paid the bill, you can’t get it back on until you’ve paid the arrears AND a reconnection fee. When you borrow to tide yourself over, you pay much higher interest rates than the rest of us - including to ‘payday lenders’ and pawnbrokers.

When the people you counsel complain about the high cost of living, I’m inclined to believe them and be sympathetic. But in recent years it’s become fashionable for people in the comfortable world also to complain about the high cost of living, and there is little objective evidence to support these complaints. Nothing special.

I suspect people complain about the cost of living when they don’t have anything more serious to worry about - such as having to find a job or even the risk they may lose their job. I also suspect the complaints of the comfortably off mostly boil down not to the high cost of living but the difficulty some people encounter achieving the higher standard of living to which they aspire. No matter how high your income, it's always possible feel financially stressed if you over-commit yourself. You can often have difficulty making ends meet if your income is always fully committed and you leave yourself no buffer to cope with unexpected expenses, such as a big increase in utility bills.

Compare that with ‘Michael’ who was outraged when my colleague Peter Martin wrote that anyone earning more than $210,000 a year was ultra-rich, in the top 1 per cent. Michael wrote that $210k gross translated to $140k after tax. “Assuming a $600k mortgage (appropriate to this level of income) and two children in private schools plus additional outgoings this leaves a balance of only $21k for holidays and other incidentals and/or saving.” Peter wrote back assuring him that, however difficult his circumstances, 99 per cent of Australians earned less than he did.

There is plenty of research evidence suggesting people’s notions of where they fit in the distribution of family income - from low to middle to high - are often wildly astray. Everyone wants to think they’re somewhere near the middle. So let me give you Peter’s test: what at do you think was the average income reported to the Tax Office in 2010-11 (excluding all the low earners who don’t end up paying tax)? The average income earned by the Australians who did pay tax was less than $67k.

As financial counsellors well know, many people have a low level of financial literacy. Many people also have low factual knowledge of the hip-pocket effects of government tax and benefit changes. A recent survey by the progressive think tank Per Capita found that more than half of respondents believed the carbon tax had increased the price of petrol, when it doesn’t apply to petrol. Most respondents estimated the tax had increased their cost of living by $20 a week or more, whereas the Treasury estimate was just under $10 a week. And almost half of respondents claimed to have received no compensation from the government in tax cuts or benefit increases, whereas Treasury’s estimate was that 90 per cent of households would get some compensation and about two-thirds would be fully compensated.

Everyone has their own perspective on the economy. There’s the reality and the perception - and the two are often very far apart.