Monday, April 21, 2014

Greed is the market's forgotten vice

Where do Easter and business intersect? Well, what about at greed.

According to Dr Brian Rosner, principal of Ridley Melbourne, an Anglican theological college, greed has been glamorised by the market economy and is a forgotten sin.

Maybe it's this that allows those Christians who are business people, economists and politicians to share their colleagues' commitment to unending economic growth and an ever-rising material standard of living.

In his book, Beyond Greed, Rosner defines greed as ''wanting more money and possessions'', a refusal to share your possessions and ''the opposite of contentment''.

Greed has always been with us, and insatiability isn't unique to modern Western civilisation, but we're certainly giving it a workout. To us, money is the simplest measure of whether you're winning at the game of life.

But what is unique to our age, according to another author, is the cultural acceptance, even encouragement of insatiability. A survey of regular churchgoers in America found that whereas almost 90 per cent said greed was a sin, fewer than 20 per cent said they were ever taught that wanting a lot of money was wrong, and 80 per cent said they wished they had more money than they did.

It seems that, by comparison with the past, greed is regarded as a trivial sin. A retired priest has recounted that, in his long years of service, all kinds of sins and concerns were confessed to him in the confessional, but never once the sin of greed.

But Rosner's having none of that. He says greed is at the heart of three major threats to our existence as individuals and societies: pollution, terrorism and crime.

Pollution is caused by human unwillingness to pay the price for the cleaner alternative (ain't that the truth, Tony). ''On any reckoning, climatic change due to the effects of pollution could cause major 'natural' disasters in the days to come,'' he says.

In most cases of terrorism, each side accuses the other of some form of greed, whether involving people, land or property. ''Greed also fits both sides of the equation in many cases of crime,'' he says. ''Thieves steal because they want more, and often because they perceive the victims as having more than their fair share.''

The greedy are those who love money inordinately, trust money excessively, serve money slavishly and are never satisfied with their possessions.

Rosner says greed is a form of religion, the religion of Mammon. Literally, mammon means wealth or possessions, but it could just as easily be taken as the biblical word for the economy. And if greed is a religion, that makes it a form of the greatest of all sins: idolatry. (First Commandment: you shall have no other gods before me.)

In Western society, the economy has achieved what can only be described as a status equal to that of the sacred.

''Like God, the economy, it is thought, is capable of supplying people's needs without limit. Also, like God, the economy is mysterious, unknowable and intransigent,'' he says. ''It has both great power and, despite the best managerial efforts of its associated clergy, great danger. It is an inexhaustible well of good(s) and is credited with prolonging life, giving health and enriching our lives.

''Money, in which we put our faith, and advertising, which we adore, are among its rituals. The economy also has its sacred symbols, which evoke undying loyalty, including company logos, product names and credit cards.''

Rosner says we have to distinguish between the legitimate enjoyment of material things, which the Bible takes for granted, and an illegitimate and unhealthy attachment to wealth as an end in itself.
But if we don't want to be greedy, what should we be? Contented.

''To be content is to be satisfied, to enjoy a balance between one's desires and their fulfilment. To be content is in effect to experience freedom from want,'' he says. But note, it's being content with your own lot, not those of others less fortunate than you.

And the other side of the contentment coin is giving. Rosner says that if Charles Dickens' Scrooge epitomises greed, giving is epitomised by Victorian jam maker Sir William Hartley. Hartley regularly and voluntarily increased wages, practised profit-sharing and supplied low-cost, high-quality housing to some of his employees and free medical attention to all of them.

He was also concerned for his suppliers, and would amend contracts in their favour if a change in the price of fruit and economic circumstances conspired against their making a decent living.


Saturday, April 19, 2014

Badly taught economics has high opportunity cost

Is it possible the discipline of economics is becoming so mathematical it's in the process of disappearing up its own fundament?

While you're thinking about that, let me take the opportunity to ask you a quiz question (it's a holiday weekend, after all).

You've won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you'd be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer.

So what is the ''opportunity cost'' of seeing Clapton? Is it $0, $10, $40 or $50? Take your time (especially if you fancy yourself as an economist).

The opportunity cost of a decision is the value (benefit) of the next-best alternative. So the right answer is $10. When you go to the Clapton concert you forgo the $50 of benefit you would have received from going to the Dylan concert. But that's the gross benefit. You also forgo the $40 of cost, so the net benefit you forgo is $10.

If you didn't get the right answer, don't feel too bad. When two economists at Georgia State University, Paul Ferraro and Laura Taylor, asked that question of almost 200 economists attending a professional conference, almost 80 per cent got the wrong answer.

The answers they gave were spread across the four possible answers, with more than a quarter saying $50, apparently believing it was only the ''willingness to pay'' of $50 that was relevant.
The next most popular answer was $40, apparently because people thought the cost of a Dylan ticket must also have been the opportunity cost. Those who answered $0 must have concluded there could be no opportunity cost if the Clapton concert was free.

This left fewer than 22 per cent of respondents getting the right answer. And if that (along with your own failure to get it right) doesn't shock you, it should.

Opportunity cost is probably the most fundamental concept in economics. One introductory textbook lists it along with ''marginalism'' and ''efficient markets'' as three of economics' most fundamental concepts. Opp cost seems a pathetically simple concept, but non-economists keep forgetting to consider it - meaning they don't always make the best decisions about how to spend the limited time and money available to them.

And it seems the concept isn't as simple as we assume. If about 80 per cent of non-economists got the question wrong, that would be a pity, but not too surprising. But the respondents to the survey were, in the authors' words, ''among the most well-trained economists on the planet''. Two-thirds of the respondents had PhDs, with the remainder studying for their PhD.

What's more, more than 60 per cent of them had actually taught introductory economics courses. Those who'd taught the course were no more likely to get the right answer than those who hadn't, nor were those who'd attended one of America's top-30 graduate schools, nor those who'd graduated before 1996 rather than after it.

The only significant differences were in the economists' field of specialisation. Only the tiny number specialising in micro-economic theory got a halfway respectable score, followed well back by those doing applied micro. Worst were those doing macro or international economics.

The first reason for concern is what these results say about the quality of the teaching of economics at postgraduate level. After surveying students in seven top-ranking US graduate programs in 1987, David Colander, a leading researcher of the economics profession, concluded the programs emphasised mathematics to the detriment of empirical content and economic reasoning.

A commission on graduate education in economics in 1991 found that it generated ''too many idiot savants, skilled in technique but innocent of real economic issues''. This survey suggests little improvement since then.

Does it matter for economic research if economists can't identify opportunity cost? ''Obviously,'' the authors say, ''it matters for PhD economists who take jobs in the private or government sectors, in which opportunity costs are the fodder of daily decisions …

''Theoretical research rarely requires that an individual calculate an opportunity cost in the form of a word problem. Empirical research tends to focus more on appropriate techniques to make inferences about parameter values in models.

''But can economists be relevant in the world of ideas and policy if we cannot answer simple … opportunity cost questions?''

But whatever the failings of post-graduate teaching, there's also failure at the undergraduate level. The authors say the concept of opportunity cost is usually covered in the first week of introductory undergraduate classes and often deemed so straightforward as to not require further teaching time.

A Nobel laureate complained that ''the watered-down encyclopaedia which constitutes the present course in beginning college economics does not teach the student how to think on economic questions. The brief exposure to each of a vast array of techniques and problems leaves the student with no basic economic logic with which to analyse the economic questions he will face as a citizen.'' That was George Stigler, writing as long ago as 1963.

The authors say that ''if we are not able to instil in our students a deep and intuitive understanding of one of the most fundamental ideas that the discipline has to offer (and the idea whose frequent application could do most good in peoples' private and public lives) then we wonder what we can claim as our value-added to the college curriculum''.

It makes me wonder whether, in its preoccupation with using maths to make itself more ''rigorous'' and thus academically respectable, economics has lost its way.


Wednesday, April 16, 2014

Why manufacturing in Australia has a future

Few things about the economy are worrying people - particularly older people and those from Victoria and South Australia - more than the decline in manufacturing. But many of our worries are misplaced, or based on out-of-date information.

For instance, many worry that, at the rate it's declining, we'll pretty soon end up with no manufacturing at all. And everyone knows that, unlike other states, Victoria's economy is particularly dependent on manufacturing.

But Professor Jeff Borland, a labour economist at the University of Melbourne, has written a little paper that sheds much light on these concerns.

It's true that manufacturing's share of total employment in Australia is declining. But this is hardly a new phenomenon, which suggests the end may not be nigh. Half a century ago, manufacturing accounted for a quarter of all employment. Today it's 8 per cent.

And almost none of that dramatic decline is explained by a fall in our production of manufactured goods. The great majority of the fall in manufacturing's share is explained simply by the faster growth of other parts of the economy, particularly the service industries.

It's true, however, there's been a (much less dramatic) decline in employment in the industry over the years. Employment in manufacturing reached a peak of 1.35 million in the early 1970s. Today, it's about 950,000. Of the overall loss of 400,000 jobs, about 200,000 occurred during the '70s, about 100,000 in the recession of the early '90s and the rest since the global financial crisis in 2008.

Many people would explain this decline in terms of the removal of protection against imports in the '80s and the very high dollar since the start of the resources boom in 2003. But, in fact, the great majority of it is explained by nothing more than automation.

How do I know? Because if you look at the quantity (or real value) of manufactured goods we produce, it reached a peak as recently as 2008, and has since fallen just 6 per cent. Nowhere have the machines of the computer age replaced more men (and I do mean mainly men) than in manufacturing. Is this a bad thing? It would be a brave Luddite who said so.

The consequence is a change in the mix of occupations within manufacturing, the proportion of machine operators, drivers and labourers falling by 10 percentage points since 1984, with the proportion of managerial and professional workers increasing by about the same extent. The proportion of technicians and tradespeople is little changed.

But there's also been a change in the types of things we manufacture, with the share of total manufacturing employment accounted for by textiles, clothing and footwear falling from 11 per cent to 4 per cent since 1984, while the share accounted for by food products has risen from less than 15 per cent to more than 20 per cent.

The share of transport equipment (cars and car parts) is down, but the share of other machinery and equipment is up by much the same extent.

The next thing that's changed a lot since 1984 is the location of manufacturing in Australia. Then, almost 70 per cent of manufacturing employment was located in NSW and Victoria; today it's down to 58 per cent. Then, NSW had more manufacturing workers than Victoria; today they have 29 per cent each. (Bet you didn't know that.)

But if the big two states now have smaller shares, which states' shares have grown? The two we these days think of as "the mining states". Western Australia's share has risen to 10 per cent, while Queensland's share has almost doubled to 21 per cent. (Bet you didn't know that.)

So far, South Australia's share of national manufacturing employment has fallen only a little to 8 per cent.

This tendency for manufacturing's distribution between the states to become more even over time, plus the much faster growth of other industries, has made all states less dependent on manufacturing for employment, as well as narrowing the gap between the most dependent (SA on 10 per cent of its total employment) and the least (WA on 7 per cent).

Whereas in 1984 Victoria depended on manufacturing for 21 per cent of its jobs, today it's 9 per cent. (See what I mean about out-of-date information?) Victoria's more dependent on the health industry (12 per cent) and retailing (11 per cent), with almost as many jobs in professional services as in manufacturing.

The wider conclusion is that, though the faster growth of other industries has made all states less dependent on manufacturing for jobs, this doesn't mean manufacturing's dying. Its actual output hasn't fallen much, though it's using fewer workers to produce that output.

The unwritten story is there've been big changes in what Australia's manufacturers produce: less stuff that relies on protection against imports and more stuff that fits with Australia's comparative advantage. You see that with food products - including things such as wine-making - now being the biggest category within manufacturing, employing 20 per cent of all manufacturing workers.

You see it also in the growth of manufacturing employment in the mining states - a spillover from the resources boom.

Manufacturing is undoubtedly suffering from the high dollar. But, apart from that, it's in good shape. It has shed some fat and is fitter and wirier than it has ever been, better able to survive in a harsh world.

Monday, April 7, 2014

Our econocrats' vision is too narrow

Part of my job is making sure readers are kept fully informed about the messages our top econocrats are trying to get across to the public. They're usually much franker and clearer than the spin we get from our political leaders.

But just because I report their views faithfully doesn't mean I always agree with them.

As it related to the outlook for the economy, the message in the speech Treasury secretary Dr Martin Parkinson delivered last week fitted well with the messages we've been getting from Glenn Stevens and Dr Philip Lowe, of the Reserve Bank.

It's a warning that, between the slowdown in our rate of productivity improvement, the expected continuing fallback in mineral export prices and the reversal of the "demographic dividend" delivered by the baby boomers, "we face a significant challenge in maintaining the rate of growth in living standards that Australians have come to expect".

Specifically, Parkinson projected that, even if we assume labour productivity grows at its long-term average, the other two factors would cause real income per person to grow by just 0.7 per cent a year over the decade to 2023-24, rather than the 2.3 per cent "to which Australians have become accustomed".

So over 10 years our present annual real income of $63,600 per person would grow only to $69,000, rather than $82,000, leaving us only $5400 a year better off, rather than the $18,400 a year to which we've become accustomed.

To keep average incomes growing as fast as we've come to expect will require us to double our present rate of productivity improvement to 3 per cent a year.

Sorry, but I very much doubt we'll be willing to make the many controversial reforms needed to achieve such a transformation. More to the point, I'm not convinced we should.

The admonitions we get from our econocrats are far too relentlessly materialist and, hence, mono-dimensional. Whatever their professed "wellbeing framework", when the chips are down their advice is to make maintaining the rate at which our material standard of living is rising our highest priority, if not our only priority.

We're always being reminded of the pecuniary price to be paid for worrying about foreign ownership, or saving family farming or preserving the weekend. But the warnings never run the other way: the greater personal stress or relational problems or loss of leisure or greater social disharmony that could accompany going all out to maximise economic growth.

No one knows better than I do that you can't say everything you want to say in the time allotted for a speech or the space allotted for a column. But, even so, some obvious caveats and qualifications almost never rate a mention.

The most obvious is the environment. What reason is there to believe acting to maintain our rate of growth won't do significant further damage, even unacceptable damage to the ecosystem? How do we know continuing climate change - a problem about which we've decided not to make a genuine contribution to international efforts to combat - won't negate our productivity-raising efforts?

How can we talk about capturing a big share of the growth in Asia's demand for Western foodstuffs without mentioning climate change?

To be fair, their present political masters are so down on the environment that our econocrats aren't free to speak on the subject. Parkinson is facing the sack for having been chief designer of the emissions trading scheme (including the Howard government's version) and his successor - an outstanding Treasury officer - has already had the chop. It's a wonder Professor Ross Garnaut isn't behind bars - or at least had his office raided by ASIO.

Another obvious but never-mentioned caveat is the distribution of all this increased income. It's all very well to talk about increasing the average income, implicitly assuming the extra income will be shared in line with the existing distribution. Our experience of income growth over the past 30 years is that a disproportionate share ends up in the hands of the people at the top.

Why no mention of this when ordinary workers are being asked to support reforms that could cost them their jobs?

More basically, how do the econocrats know we'd find a slower rate of growth in our affluence bitterly disappointing? They don't. Their confident claims that we would are based on their faith in materialism, not evidence.

Most of us are condemned to spend 40 years of our lives working 40 hours a week. Why do econocrats never wonder whether making that work more satisfying would do more for our "wellbeing" than making extracting more productivity from our labour the only priority?

Saturday, April 5, 2014

Treasury's opportunities and threats facing our economy

It shouldn't surprise you that when the secretary to the Treasury, Dr Martin Parkinson, devoted half his major speech this week to "fiscal sustainability" - the tax increases and spending cuts needed to get the budget back on track - the media virtually ignored the other half.

But the budget isn't the economy. And in that other half Parkinson offered a revealing SWOT analysis of the economy, outlining its Strengths and Weaknesses, Opportunities and Threats. So let me tell you what he said (and leave my critique for later).

For people worried about what we do for an encore after the resources boom - about where the jobs will come from - Parko points to three big "waves of opportunity".

The first wave is the mining investment boom, which is ending but not leaving us high and dry. "With the capital stock in the mining and energy sectors now triple what it was a decade ago, additional productive capacity will drive strong growth in resources exports for several years to come," he says, although this will involve employing fewer workers than in the investment phase.

The second opportunity wave flowing from the vast economic shifts in Asia is rising global demand for agricultural produce. The Australian Bureau of Agricultural and Resource Economics and Sciences estimates that China's imports of fruit will treble by 2050. Imports of beef will grow by a factor of 10 while imports of sheep and goat meat increase by a factor of 19. Dairy will increase by a mere 165 per cent.

Asia already takes more than 40 per cent of our food exports. Parko warns, however, that our ability to gain a slice of its rising demand rests on continued productivity gains in our rural sector, supported by the right policy settings.

"Our handling of the concerns raised by foreign ownership of Australian agricultural land (and food manufacturing) in some parts of our community is one dimension of the agricultural policy challenge, along with our approach to trade policy, stimulating investment in on- and off-farm infrastructure and supporting research and development."

The third wave is the opportunities in the services and high-value manufacturing sectors brought about by the steadily increasing growth of the Asian middle class. It's estimated that, by 2030, just under two-thirds of spending by the world's middle class will come from the Asia Pacific region, compared with about a quarter today.

"To capture the benefits of the third wave, we will need to compete on the global stage for Asian demand for services and high-end manufactures on the basis of both cost and quality," he says. "We will also need to compete for foreign direct investment to help put the right export-related infrastructure in the right places."

But get this declaration from the economic rationalist-in-chief: "Contrary to how it is sometimes portrayed in the media, competing on the global stage does not mean driving down wages or trading off our standard of living. Far from it."

Parko says improving Australia's competitiveness in global markets means investing in the skills of our workforce so Australians have the opportunity to move into sustainably higher paid jobs, and investing in infrastructure that has a high economic return.

It means ensuring firms and their employees are freed from unnecessary regulatory burdens, and establishing the right incentives to encourage innovation and competition. "In other words, it means raising Australia's productivity performance," he says.

Which brings us to Parkinson's three big threats to our further economic success. The first is productivity improvement. He says that, even after you allow for temporary factors, there's been a slowdown in "multi-factor" productivity improvement that's broad-based across industries, suggesting that deeper, economy-wide factors are at play.

The second threat arises because, until mid-2011, the effect of this productivity slowdown on the rise in our living standards was masked by the rise in the prices we were receiving for mineral exports. But now the likelihood that these prices will continue falling means a "significant drag on Australia's national income growth" over the rest of this decade.

The third threat to continued strong economic growth comes from the turnaround in the "demographic dividend" delivered by the baby boomers. For about 40 years until 2010, the proportion of the population of working age (here defined as 15 to 64) grew a lot faster than the overall population because of the postwar baby boom, followed by a dramatic fall in the birth rate in the 1960s and '70s. This boosted economic growth.

"Over the next few years, this demographic dividend, which has been fading for some time, will actually reverse. The proportion of the population aged 65 and over is expected to increase to nearly 20 per cent in 2030, from 13.5 per cent in 2010."

As the population ages, the total participation rate - the proportion of people 15 and over participating in the labour market - will fall, despite the increase in the participation rate among older Australians. "This expected decline has already begun and will become more pronounced by the end of the decade," he says.

Productivity is the key long-run driver of income growth, but declining export prices and labour-force participation are expected to subtract from national income growth in future.

If we assume the productivity of labour grows at its long-term average, then income per person would grow over the coming decade by about 0.7 per cent a year, about a third of the rate to which we've become accustomed, he says. To avoid that, we'd need to sustain labour productivity growth of about 3 per cent a year, about double the rate we've achieved so far this century.

If we fail to make the reforms needed to achieve that rate of productivity improvement, by 2024 our income per person will have risen only to $69,000 a year, not $82,000. We'll each be $13,000 a year less affluent than we could have been.

Wednesday, April 2, 2014

Bracket creep has become highly regressive

If you think you're having trouble coping with the rising cost of living now, just wait until you see what the politicians have in store for you over the next three years. In all likelihood, you'll be losing a significantly higher proportion of your pay in income tax, though people on low incomes will be hit a lot harder than those on high incomes.

This will happen because an increase in the overall tax we pay is inevitable, but it suits both sides of politics to avoid the obvious, up-front increase that would come from raising the rate of the goods and services tax (or from extending the tax to spending on fresh food, education and healthcare) and rely on what Malcolm Fraser called "the hidden tax of inflation" - otherwise known as bracket creep.

The pollies know voters much prefer any increase in taxation to be hidden from their view. Trouble is, the increase in "marginal" tax rates (the tax on the last part of your income, such as on a pay rise or some overtime) many workers face will be so big, you'd have to be pretty thick not to notice.

Treasurer Joe Hockey has been softening us up for the tough budget he's preparing for next month. Fine by me. But he's studiously avoiding admitting there's no way his spending cuts will get the budget back into lasting balance. He's pretending all the problem is on the spending side (and all caused by Labor), when he knows the problem on the budget's revenue side is just as big, if not worse.

Consider the facts. Collections from company tax - which account for about a fifth of total tax collections - aren't likely to grow any faster than the economy (gross domestic product). And collections from indirect taxes - which include the goods and services tax and excises on alcohol, tobacco and petrol - are likely to grow a lot more slowly than GDP.

Collections from excises are declining relative to the rest of the economy, partly because John Howard abolished the indexation of the petrol excise, but also because consumers' spending on alcohol and tobacco accounts for an ever-declining share of their total spending.

Collections from the GST are also in relative decline, because consumer spending has stopped growing faster than the overall economy (as it did when households were borrowing heavily) and because consumers' spending on items subject to the GST is growing more slowly than overall consumer spending. Putting it another way, private spending on untaxed education and healthcare is growing faster than our spending on taxed items.

That leaves collections from income tax, which account for about half the federal government's total collections. Assuming regular tax cuts, income tax collections will grow in line with GDP. Only if further tax cuts are avoided will continuous bracket creep mean income tax collections grow strongly enough to make up for the revenue-raising deficiencies of the GST and other indirect taxes.

Guess what? All the budget projections Hockey is using to justify big cuts in government spending assume no further income tax cuts. Without that assumption the underlying weakness on the tax side would be apparent.

His first reason for ignoring the budget's revenue-raising weakness is his need not to expose as wishful thinking the line Tony Abbott ran from the moment he became Liberal leader, that the Libs stood for low taxation, opposed all "great big new taxes on everything" (except the GST, of course) and should be voted for by anyone who didn't like the sound of the carbon tax or the mining tax.

Hockey's second reason is that any hint of increasing the GST (or any other tax) would allow Labor to do to Abbott what Abbott did to Labor. The party of higher government spending opposes the other side's new taxes for reasons of blatant political advantage.

But Labor also professes to oppose the GST because it's "regressive" - taking a higher percentage of low incomes than of high incomes. It must face the unpalatable truth that the past eight tax cuts have left us with a rate-scale that now makes bracket creep highly regressive.

Consider this. The average full-time wage next financial year, 2014-15, will be about $76,000. On the basis of reasonable assumptions about the growth in wages over the three years to 2017-18, you can calculate that someone on half the average wage would see the proportion of their wage that they lose in tax increase by 3.5 cents in the dollar.

For someone on the average wage the increase would be 2 cents in the dollar. On twice the average wage it's 1.1 cents. And on six times the average wage it's 0.8 cents.

Now that's regressive. Does Labor really think a rise in the GST would be much worse?