Monday, November 30, 2015

Let’s not repeat our many competition stuff-ups

The belief that increased competition leads to greater efficiency and higher productivity is one of the articles of faith for admission to the economic priesthood.

Economic practitioners often know little about the peculiarities of particular markets – about their specific areas of market failure – and often don't think they need to know because what they do know about is their profession's two magic answers to inefficiency.

The first is to "get the incentives right" (the claimed rationale for much tax reform) and the second is to increase competitive pressure.

There's a lot of truth to both propositions, but not as much as it suits economists to believe. Because it comes from their model of markets, many economists' belief that the more competition the better – and the more choice the better – is so deeply ingrained it requires no empirical confirmation.

This makes economists chronic sufferers from what psychologists call "confirmation bias" – they make a mental note of all the examples they see that seem to confirm their pre-existing views about how the economy works, but quickly forget those examples that don't.

So when the Turnbull government confidently asserts that implementing the many recommendations of Professor Ian Harper's review of competition policy will do much to lift the economy's rate of productivity improvement, few economists are inclined to demur.

Many of the reforms Harper proposes make much sense: ending the protection of chemists, coastal shipping and the owners of taxi licences and intellectual property, rationalising the pricing regimes for roads and water, and changing to an "effects test" in trade practices law.

Initially, Harper wanted deregulation of liquor licensing laws, but pulled back when economists who did know about the market failures in the area showed him evidence of the significant "negative social externalities​" (e.g. people getting bashed outside pubs) associated with alcohol consumption. Who knew?

Unfortunately, Harper's church-going ways haven't helped him appreciate the potentially adverse effects on family life – family life? Why would an economist know or care about family life? – arising from further deregulation of retail trading hours.

We'll see how many of Harper's braver proposals are actually implemented. In any case, most of them are up to the premiers, not the feds.

But the most potentially alarming is Harper's proposal that the principles of competition policy be extended to the domain of "human services" – healthcare, education and community services – which is mainly the responsibility of the states.

There's no denying that health and education are areas of huge government spending and economic significance, replete with inefficiencies and ineffectiveness. They ought to be much higher on the reform agenda than yet more tinkering with the tax system and the wage-fixing rules.

But to frame them as part of competition policy is an old economists' trick: take an area that's always been outside the marketplace and marketise​ it. Take the world as it is and make it more like the textbook assumes it to be.

Apply the economists' two magic answers – getting the incentives right and introducing competition and choice – and everything will fix itself without the economists ever needing to come to grips with the causes of the particular inefficiencies that are causing the problem.

Brilliant. But often disastrous. Think of the string of stuff-ups that have followed the econocrats' efforts to contract-out the provision of government services.

Think of the allegations of widespread rorting by operators of the job services network that replaced the Commonwealth Employment Service.

Think of the way contracting-out of childcare services allowed the rise and collapse of ABC Learning, at great cost and inconvenience to parents and taxpayers.

Think of last week's collapse of Vocation Ltd and the much wider rorting of the misguided experiment with profit-motivated provision of higher education. Federal and state "reformers" are totally stuffing up vocational education in response to the problems with TAFE.

Think of all the money federal taxpayers have pumped into private schools in the sacred name of choice, without any evidence of this wider competition leading to higher standards of education on either side of the fence.

Think of all the effort put into the MySchool website to promote choice and competition while our scores continue to slide on the international indicators of literacy and numeracy.

Even the pink batts scheme is an example of the disaster – and death – that can follow when you naively give profit-motivated business people a pipeline into government coffers.

Sorry, econocrats. If you want to achieve genuine improvements in the delivery of health and education and community services, you'll have to try a mighty lot harder than applying magic answers.

Saturday, November 28, 2015

GDP slows as population slows

When is slower economic growth not such a bad thing? When it's caused by lower growth in the population.

If that puzzles you, you're a victim of the economists' practice of focusing on growth in gross domestic product rather than GDP per person.

Nigel Ray, a deputy secretary of Treasury, acknowledged in a speech to the Australian Business Economists this week that last financial year, 2014-15, the economy recorded its third straight year of below-trend growth.

"This means Australia is now in a prolonged period of below-par growth, the likes of which we have rarely seen outside of a recession," he said.

We'll be seeing the national accounts for the September quarter on Wednesday, but they're unlikely to show much improvement.

Reserve Bank heavies have been hinting at it for months, but this week Ray made it official: the economy's trend rate of growth is actually lower than the econocrats had been assuming in recent years.

But what exactly is "trend" growth? Good question because there are actually two versions of it (or three if you include the Bureau of Statistics' practice of referring to its smoothed seasonally adjusted estimates as "trend" estimates).

The backward-looking version of trend is the economy's average actual rate of growth over past 10 years or more. Since 1976-77, for instance, real GDP has grown at an average rate of 3.1 per cent a year.

If nothing in the economy ever changed, the backward-looking version of trend would be the same as the forward-looking version, but things do change.

The future trend rate of growth is also known as the economy's "potential" rate of growth, the maximum rate at which it can grow over the medium-term – periods of five or 10 years or so – without causing a big problem with inflation.

The economy's potential rate of growth is the rate at which its ability to produce goods and services is growing.

This, therefore, refers to the supply side of the economy. The supply side involves combining the economy's three "factors of production" – land, labour and capital – to produce goods and services.

Here, "land" includes natural resources and "capital" means man-made, physical capital, such as buildings and equipment, but also roads and other public infrastructure.

But the economists' custom is to view the economy's supply side – its capacity to produce goods and services – through the perspective of just one factor, labour.

So the economy's potential output is seen as being determined by "the three Ps": population, participation and productivity. Potential growth in production is determine by growth in the population of working age (everyone 15 and over) plus change in the rate at which people of working age choose to participate in the labour force by working or seeking work, plus growth in the productivity of labour (average output per hour worked).

Of course, the economy's potential to supply goods and services is only half the story. How much is actually produced in any period will be determined by the demand for goods and services at the time.

Demand can't exceed supply (when it tries, the excess demand that can't be satisfied from imports just forces prices up), but it can fall short of potential supply. When it does, labour is unemployed or underemployed (people not working as many hours as they want to) and factories and offices have idle capacity.

That's the position we've been in for the past three years: the growth in our demand for goods and services has been falling short of the growth in our potential to supply them. So when the econocrats say growth has been "below trend", that's what they mean.

And every year that actual output falls short of our potential output we get a widening in what economists call "the output gap", which will be manifest in rising unemployment or underemployment as well as unused production capacity in factories and offices.

Whereas we usually think of potential output as an annual rate of growth, the output gap is measured as the difference between the absolute levels of potential and actual output.

The size of the output gap is an indicator of the failure of the managers of the macro economy to achieve their goal of keeping its actual growth in line with its potential growth – that is, to keep it growing at full capacity or "full employment" (of all the factors of production, not just labour).

The continued existence of the business cycle means they can never achieve this goal, of course, but it's still their job to try.

The size of the output gap is also a measure of the extent to which a recovering economy can for a few years grow faster than its trend (potential) rate without that causing any inflation problem. A period of above-trend growth is actually the only way to eliminate the output gap and get the economy back to growing at its full-employment rate.

For some years the econocrats' estimate has been that the economy's potential or (forward-looking) trend rate of growth is 3 per cent a year, compared with its actual growth over the year to June of 2.3 per cent.

Ray said this includes an assumption that the working-age population grows by 1.75 per cent a year, its actual rate over the past 10 years. But now actual growth has slowed to 1.5 per cent because of a decline in holders of temporary visas and lower net migration from New Zealand.

So Treasury has cut its estimate of trend (potential) growth to 2.75 per cent, thereby reducing its estimate of the size of the output gap.

Why is this not such a bad thing? Because, although the growth in workers helping to produce goods and services is likely to be lower than we thought, there'll also be fewer people we have to share those goods and services with. GDP per person shouldn't be much affected.

Wednesday, November 25, 2015

Oldies looked after while young don't notice

If I was going to wander around the inner city chalking messages on the pavement in copperplate, they wouldn't say Eternity. They'd say Wake Up. Why? Because, contrary to rumour, the Nanny State doesn't exist.

If you fail to pay attention because you assume that the market economy will always deliver you a square deal, you're heading for disillusionment. If you think it's the government's job to ensure no one ever rips you off, you have much to learn.

Indeed, it's just as likely to be the pollies who decided to short-change you when they realised you were too busy watching reality television to notice.

Take the great debate about tax reform. Now the best-informed are telling us the government has thought better of changing the goods and services tax, I fear the debate will turn in a distinctly more boring direction – to reducing the generosity of tax concessions for superannuation.

Mention super and everyone over 50 pricks up their ears, while everyone under 50 wonders what's on telly tonight. To date, that's meant that the over-50s have been looked after at the expense of the under-50s.

To date, the debate over super tax concessions has been about their rapidly growing cost – about $25 billion a year in reduced tax collections – and the fact that the lion's share of this loss to the budget goes to high-income earners (like me). That is, it's a question of fairness between rich and poor.

But in their latest paper on super tax concessions, to be released on Wednesday, John Daley, Brendan Coates and Danielle Wood, of the Grattan Institute, argue that the reform of super can also be advocated on the grounds of fairness between the old and the young.

It's not something often talked about, but our budget and social security arrangements – as with all advanced economies – have a "generational bargain" built into them.

The bargain is simple: except perhaps for the period when they're raising a family, people of working age generally pay more in tax than they get back in benefits, with the difference used to provide those who are too old to work with a lot more in benefits than the little they pay in taxes.

Since we all expect to get old one day, this was regarded as a quite fair bargain between the generations. And until recently, paying for it all wasn't a big problem, because the number of workers was growing a lot faster than the number of oldies.

What's changed is the ageing of the population and the retirement of the baby boomers, which means the number of oldies needing to be supported from the budget has started growing a lot faster than the number of workers.

But Daley and his co-authors point out that it's not just demography that's undermining the generational bargain. The politicians have been making it worse by increasing the generosity of benefits to the old.

In Australia's case, John Howard was always slipping extra benefits to the alleged "self-funded retirees", who he regarded as a key part of the Liberal heartland. He gave them the senior Australians tax offset and made it easier for them to get health cards and the pensioners' rate for pharmaceutical benefits.

Then Peter Costello came along and made a lot of supposedly self-funded people eligible for a part pension, as well as making super payouts completely tax-free for people over 60.

Not to be outdone, Kevin Rudd granted pensioners a big discretionary increase on top of regular indexation to average weekly earnings.

Daley and his colleagues show that the largest increases in government spending have been on healthcare (where federal and state governments spend twice as much on each 60-year-old as on a 30-year-old) and the age pension.

"Both of these spending categories grew substantially faster than gross domestic product, not because of the ageing of the population, but because of explicit and implicit choices to spend more per person of a given age," they say.

In 2010, and after removing the effect of inflation, the two levels of government spent $9400 a year more per household over 65 than they did six years earlier. At the same time, the average amount of income tax paid by those 65 and over fell in real terms, despite an increase in incomes.

This generosity has been funded by running budget deficits and borrowing to cover them. Who'll be paying the interest on that debt? Not the oldies.

Over the past decade, according to Grattan's calculations, older households captured most of the growth in Australia's wealth. Households aged between 65 and 74 years today are $400,000 (or 27 per cent) wealthier in real terms than households of that age 10 years ago.

Meanwhile, the wealth of households aged 25 to 34 years fell by $2000 (or 4 per cent).

This is partly explained by rising house prices, of course. Older households are far more likely to own their home than younger households. And, of course, the value of their home is ignored when assessing their eligibility for an age pension.

If the young do take an interest in the reform of super tax concessions, they'll find they're being asked to agree to exclude themselves from the largess being enjoyed by the older generation. But until a halt is called, the generational unfairness will keep worsening.

Monday, November 23, 2015

Lower-tax dream feeds the budget deficit

Remember when we used to worry about the budget deficit? In case you've stopped following the story, recent developments are well summarised by a headline: Lucky we don't have a revenue problem, because revenue looks bad.

The big budget news last week was that wages grew by just 2.3 per cent over the year to September, taking wage growth in the private sector - of 2.1 per cent - to its lowest in the 18-year history of the wage price index.

Add to that the recent weakness in iron ore and other commodity prices and it won't be surprising to find Treasury revising down its revenue forecasts yet again when we see the mid-year budget review next month.

The closer the review's publication is to Christmas, the more anxious we'll know the government is to avoid having us realise how far the Coalition's concern about debt and deficit has receded.

Apart from the dishonest nonsense the Coalition talked when in opposition, you could feel some sympathy for it as, like its Labor predecessors, it watches Treasury's confidently predicted resurgence in tax collections fail to materialise year after year.

But it's hard to be sympathetic when you find the new Treasurer, Scott Morrison, instead of seizing the God-given opportunity to set his predecessor's follies behind him, jumping into Hockey's hole and starting to dig.

Morrison hadn't been in the job long before he began repeating a line Hockey had belatedly stopped repeating that, with the budget, "we don't have a revenue problem, we have a spending problem".

Why would any treasurer in his right mind say such a patently stupid thing? Because he's allowing ideological preference to override the plain facts.

There's a strong anti-government prejudice alive in the hard right of the Liberal Party, which proceeds on the assumption that all increases in government spending are wasteful and wrong, whereas all cuts in taxes and increases in tax expenditures are a step forward, even if they add to the budget deficit.

There's some sympathy for these prejudices among economists because their neo-classical model of markets assumes a world composed solely of individual consumers and firms, and thus has a built-in presumption against the legitimacy of any form of collective action.

So, though it's true that Labor's big, unfunded spending plans are part of the present budget problem, it's necessary for the anti-government brigade to insist that excessive spending is the only problem.

The eight tax cuts in a row and Peter Costello's unsustainably generous increases in superannuation tax concessions simply can't be part of the problem since, by assumption, all reductions in tax are a good thing.

Trouble is, this prejudice is what shaped the most politically disastrous budget in living memory, the one that did most to cause its treasurer and prime minister to be deposed within the following 18 months.

The 2014 budget sought to return the budget to surplus almost solely by measures to reduce the growth of government spending, but was repudiated by the electorate and the Senate.

The plain fact is, the great majority of voters are not anti-government. They won't tolerate serious cuts in spending on welfare, health or education, even if they're often tempted by happy talk of lower taxes.

You'd expect the man who lusted after Hockey's job to be the first to get that message, but apparently not. So it's time for Malcolm Turnbull to come in over the top and set the government's thinking on a more sensible course, just as he's doing with defence and security.

Both history and commonsense say the budget won't be got back on track without both spending cuts and revenue measures, particularly cuts in tax expenditures such as super concessions.

Tax reform is the enemy of budget repair. It's being pushed by people who really believe the dream of lower taxes (for them, if not for everyone else).

If the tax package doesn't worsen the budget deficit directly - as it probably will - it will harm it in an opportunity-cost sense by appropriating tax-expenditure savings that should have been used to reduce the deficit.

Tax reform is shaping as a huge anticlimax. By the time Turnbull knocks it into shape politically it will involve a lot of change and political risk, while leaving a lot of people feeling short-changed in the lower-tax department and achieving surprisingly little in the way of improved economic efficiency.

As every Treasury intergenerational report reminds us, tax is headed inexorably up, not down.

The sooner Turnbull kills off the lower-taxes pipe dream, the better he'll be able to manage the nation's affairs.


Saturday, November 21, 2015

Don't imagine China's troubles to be bigger than they are

Is the Chinese economy slowing down or melting down? You don't have to go far to find someone purporting to know a lot more about China than you do, who's making the most apocalyptic predictions.

And who knows? Maybe one day they'll be right. But I'll wait for it to happen before I start worrying.

By the same token, to say China is "slowing" seems a bit euphemistic. Being a developing country you can't say it's in recession the way you might say it of an advanced economy, because developing economies rarely experience an actual contraction in real gross domestic product.

At their worst they just grow at rates that, by their standards, are pretty bad, but by ours we'd be very pleased to have. In that sense it seems likely China is in or entering its own version of a recession.

Its rate of growth has been slowing for more than a year, it probably has more slowing to do, and with a bit of bad luck it could slow a lot more. At worst we're talking about growth in GDP slowing to maybe 4 per cent a year.

The biggest problem – as the doomsayers have long been saying – is the "overhang" from China's long-running real estate boom, in which far more apartments were built than there were people wanting to buy them.

Now housing construction has come to a halt in various parts of China, and it won't resume until the existing stock of empty homes is finally sold off. That could take at least a year, probably two. So the economy won't start to pick up anytime soon.

Limited housing construction means weak or declining growth in the manufacture of housing materials such as crude steel, cement and plate glass.

That's not the whole story, but it does mean the weakness is concentrated in construction and manufacturing, which just happen to be the main components of "industrial production" – an economic indicator the world's financial markets pay great attention to, not least because it's published monthly.

Trouble is, industrial production ain't easy to measure. It's particularly hard to do in developing countries, which don't have the bureaucratic infrastructure we have and where the shape of the economy keeps changing, not to mention the extra problems in measuring it monthly rather than quarterly.

This has prompted some in the markets to suspect a conspiracy rather than a stuff-up, and allege the Chinese authorities are making the numbers up. They may not be as reliable as we'd like, but don't believe that.

Another thing to remember – as people in the market tend to forget – is that industrial production accounts for only about 45 per cent of Chinese GDP. The remaining 55 per cent is in a lot better shape, as a Reserve Bank assistant governor, Dr Christopher Kent, argued in a speech this week.

By the way, if you're looking for someone to trust on China you could do worse than our central bank. It's well aware of the importance of China to our international prospects and so puts a lot more personpower than most into studying it: six or seven economists in Sydney, plus another two attached to our embassy in Beijing.

Kent says that although the weakness in China's property and manufacturing sectors is clearly of concern to commodity exporters like Australia, there are a number of countervailing forces supporting broader activity in China.

"First, growth in the services sector [worth about 45 per cent of GDP] has been resilient, and should continue to be assisted by a shift in demand towards services as incomes rise," he says.

"Second, growth in household consumption has also been stable in recent quarters, aided by the growth in new jobs. Of course, such outcomes cannot be taken for granted; if the industrial weakness is sustained, it might eventually affect household incomes and spending.

"Third, Chinese policymakers have responded to lower growth by easing monetary policy [access to loans] and approving additional infrastructure investment projects.

"They have scope to provide further support if needed, although they may be reticent to do too much if that compromises longer-term goals, such as placing the financial system on a more sustainable footing."

So what does this mean for us? The substantial slowing in industrial production has contributed to the further decline this year in the prices we get for our exports of coal and iron ore. (Of course, the bigger reason for the lower prices we're getting is the substantial increase in the supply of these commodities from places such as Australia.)

Kent says that what transpires with China's industrial production, and in Asia more broadly, will have a big influence on how much further commodity prices fall.

And the changing nature of China's development – a higher proportion of services and lower proportion of goods – limits the potential for commodity prices to go back up.

But here's the good news: Kent reminds us that the shift in demand towards services and Western agricultural products in China and Asia more broadly presents new opportunities for Australian exporters.

As recently as the mid-noughties, China's GDP was growing at the rate of 10 per cent. This is why money-market types are shocked to hear it's now growing by only 6.5 per cent, let alone 4 per cent.

But this just shows that even money-market types can be innumerate. As the distinguished former economic journalist Anatole Kaletsky has reminded us, China's GDP today is $US10.3 trillion ($14.5 trillion).

In 2005 it was $US2.3 trillion. So even just 4 per cent of $US10.3 billion is much more than 10 per cent of $US2.3 trillion.

To the Chinese, what matters most is the rate at which GDP is growing. To the rest of us, however, what matters is the size of the absolute addition the Chinese are contributing to gross world product.

Wednesday, November 18, 2015

Terrorism: we must learn to think like economists

I've spent a lot of my life arguing that the hard-headed "rational" analysis so beloved of economists needs to be tempered by human emotion. But it also works the other way: sometimes we need to curb our emotional reactions and force ourselves to think coolly about what we really want and the most sensible ways to go about getting it.

I think this every time we're faced with another terrible act of terrorism. The first emotions are shock and horror, soon followed by a desire to hit back, to find a government to blame and demand action from. Promise us this will never be allowed to happen again.

Such reactions are only human, but when we surrender to them, we leave ourselves open to manipulation by the unscrupulous – and I don't just mean the terrorists.

But that's a good place to start. Terrorism is practised by the weak to get under the guard of strong. Their goal is not so much to terrify us and weaken our resolve as to provoke us into doing something stupid; something that damages us and benefits them.

Vengeance, retaliation, belligerence – these are common emotions at times like this, particularly among men. The great temptation at present is to send all our military might to the Middle East and defeat these forces of evil once and for all.

But how many times have we tried that without it working?

It's not easy to defeat your opponent so completely that no problem remains. It's much easier to make a strike that doesn't fix anything and actually makes things worse.

It never crosses the mind of the bellicose among us that the other side may be hoping to provoke us into hitting back. Why? To make them into martyrs, to show it's Muslims against the world, and to win them support from young potential fighters or terrorists in our midst.

Even the heroes who indulge themselves by shouting at women wearing headscarves are helping the side they hate.

It's arguable that, in its desire to punish someone after the terrorist strikes of September 11, 2001, the US has made things worse for itself and the rest of us. It's doubtful how much lasting benefit will result from all the lives lost and money spent in Afghanistan.

And the decision to invade and occupy Iraq has achieved little, but has destabilised long-standing enmities in the Middle East, greatly increased hatred of the US and, as the rise of Islamic State demonstrates, created a quagmire from which the Americans can't extract themselves.

No one's allowed to say it, but it's obvious: every time Australia muscles its puny way into these problems on the other side of the world – as if the Americans and Europeans need our help – we increase the risk of terrorism Down Under.

It's funny that the people who worry most about the "unsustainable" growth in government spending, tend to worry least about ever-increasing spending on defence, policing, security and surveillance.

Years of contact with economists has made me hyper-conscious of people using the media to push their vested interests. Almost all the alleged terrorism experts broadcast by a wide-eyed media at times like these seem to have a single message: do more, spend more. Oh, the risks we face.

All the understandable attention the media devote to terrorist attacks, anywhere in the world, can't help but leave us with an exaggerated impression of the risk of such an attack happening here.

A few years ago, Mark Stewart, a professor of civil engineering at my own University of Newcastle, estimated that the risk of an Australian being killed in a terrorist attack is one in 7 million each year, which is about the same as the risk of being struck by lightning.

It's not possible for our politicians to guarantee nothing bad will ever happen to us. But it is possible for them to cover their backsides by spending lots of money, progressively diminishing our freedoms in the name of protecting them, and putting on a show at airports.

A timely article in this week's issue of The Economist says that "a lot of what passes for security at airports is more theatrical than real".

Despite the likelihood that the recent Russian plane crash over the Sinai desert was caused by a bomb in the hold, attempts to blow up airliners are quite rare, it says. And the enhanced airport security introduced after 2001 has played no role in thwarting any attacks.

The ban on carrying liquids on board was introduced in 2006 after a plot to bring down several planes crossing the Atlantic was foiled thanks to a tip-off. In the time since then, nobody has been caught trying to get liquids on board to combine into a bomb.

Nor have any would-be bombers been intercepted since the requirement for passengers to remove their shoes was brought in, after a shoe bomber trying to set off an explosion was subdued by passengers.

The US Transportation Security Administration has a budget of more than $US7 billion ($10 billion) a year, but this year government inspectors succeeded in getting fake bombs and weapons through the screening process in 67 out of 70 tests in airports across the US.

So maybe no passengers have been caught doing the wrong thing because the security is such an effective deterrent, or maybe it's largely a showy waste of our time and money.

Monday, November 16, 2015

How to fix everything: cut my tax

If I was on a mission to make big progress in increasing productivity and participation in the workforce, I wouldn't start with tax reform.

That the people who profess to be so concerned about productivity and participation have started with tax reform does make you wonder about their motivations. Especially when you realise that the primary beneficiaries of the particular reforms the urgers are seeking would be their good selves.

The motives of the Business Council and other business lobby groups are transparent: their high income-earners want to pay less tax, so are happy to see other people pay more.

To them, this is the attraction of using an increase in the goods and services tax to pay for cuts in income taxes.

The better-off (such as me) benefit because their higher rate of saving limits how much more GST they pay. They benefit even further if the cut in income tax is shaped in a way that favours high income earners.

Powerful people pursuing their self-interest is hardly surprising. Nor is seeing them seek to disguise their self-interest with happy chat about improving incentives to "work, save and invest" and professing to be terribly concerned that Oz will miss out on foreign investment or that all our top executives will be lured away by American corporations.

But if, as a would-be reformer, I did get down the to-do list as far as taxation, what "reforms" would I make?

First, I'd remember that all the bracket-creep we've subjected ourselves to in recent years is the standard way governments achieve a recovery in tax collections after they find they've earlier gone overboard with tax cuts and tax breaks - as we did in the first stage of the resources boom.

I'd remember that Treasury has overstated the extent of bracket creep because its projections assumed a much higher rate of wage growth than has transpired. It's true, however, that bracket creep is regressive, hitting people on the lower tax rates proportionately harder than people whose incomes have reached the top tax rate.

So if I felt it was time to ease up on bracket creep, I'd do it simply by lifting all bracket limits bar the top one by the same percentage, determined by the rate of price (not wage) inflation over the period. This would yield a quite noticeable weekly saving to workers.

That is, I'd belatedly do what in an ideal world I should have been doing once a year: indexing the tax scales to price inflation.

What I wouldn't do is con the punters by using the regressiveness​ of bracket creep as cover for a tax cut biased in favour of high income-earners (particularly when the earlier tax cuts and tax breaks the punters have been paying for were themselves biased in favour of high income-earners).

Second, to cover the cost of this tax cut - and possibly also to increase our tax-raising capacity to cover the future growth in health and education spending Treasury is always agonising over in its intergenerational reports - I'd increase not GST but a uniformly applied land tax (which could apply to the same tax base as local government rates).

Why? Partly because GST is a regressive tax, whereas land tax is progressive, hitting higher-income households proportionately harder than lower-income households.

Do that and the need to "compensate" low income-earners disappears - though it would be necessary to institute reverse-mortgage arrangements for asset-rich/income-poor oldies.

It would also remove the government's temptation to short-change the punters by double-counting the return of bracket-creep as compensation.

Increasing land tax would mean the reform package made the tax system fairer rather than less fair - surely an important goal of honest tax reform.

As well, universally applied land tax is more efficient than GST in that, as every economist is supposed to remember, it would do less to distort people's decisions about whether to "work, save and invest".

The argument that income from capital and, for high earners, income from labour, need to be taxed more lightly because globalisation has made financial capital and executive labour more mobile between countries, is widely used - especially by Treasury - to justify taxing consumption more heavily.

But how can these guys be fair dinkum in this argument when they're overlooking the ultimate immobile tax base, land?

Finally, though excessively generous superannuation tax concessions and capital gains tax concessions are overdue for reform, I'd use the proceeds to reduce the structural budget deficit, not throw them into the tax reform pot to help justify tax cuts for high income-earners.

It's arguable that budget repair is more important than tax reform.

Saturday, November 14, 2015

Go to ex-bureaucrats' blogs for the good oil on policy

Dr Ken Henry, a former Treasury secretary, says he can't recall a time when the debate about public policies has been poorer. I can't either, and I guess the dreaded MSM - mainstream media - is part of the problem.

But if the challenge of digital disruption has tempted the mainstream to devote more time to political colour and movement and less to debating government policies, there's one respect in which the internet has made things better.

The advent of blogging has given anyone who wants to the ability to air their thoughts to the world. A lot of blogs come under the heading of you're-entitled-to-your-opinion, but sometimes they're written by people who know a lot more about the topic than most of us and have a valuable contribution to make.

That's particularly true when academics take to blogging. One of the earliest bloggers about economic policy  was Professor John Quiggin, of Queensland University. Other high quality Australian blogsites are Club Troppo, Core Economics and, for the more libertarian, Catallaxy Files. (There was a blog called Ross Gittins, Corrected but they seem to have given up.)

The best academic blogsite is undoubtedly the uni-sponsored The Conversation. To have all those academics writing short, timely, readable pieces in their area of specialty is an invaluable contribution to the policy debate.

And then there's the blog of the former bureaucrat John Menadue, called Pearls and Irritations. Menadue brings in other contributors, and his blog is the place to go to see ex-bureaucrats casting a critical eye over present government policy.

These guys know where the bodies are buried, and no one sees through the political smoke and mirrors  more easily than they do.

Earlier this year Menadue teamed up with the former econocrat Dr Mike Keating to instigate a special series on the many challenges facing the government today, called Fairness, Opportunity and Security, with a wide range of contributions from ex-bureaucrats (including Stephen Fitzgerald, David Charles, Andrew Podger and Jon Stanford), academics (including Michael Wesley, Ian Marsh, Ian McAuley and Julianne Schultz) and academics who've spent time in government (including Ross Garnaut, Glenn Withers and Stuart Harris).

Now Menadue and Keating have turned the series into a book of the same name, published by AFT Press, which they asked me to launch last week. It covers 13 topics ranging from the role of government to the economy, foreign policy, health, the environment and Indigenous affairs.

In his discussion of the way vested interests seem to have excessive influence over policymaking, Menadue notes the remarkable rise of the lobbying industry, estimating there are now more than 1000 lobbyists operating in Canberra.

"The health 'debate' is really between the minister and the Australian Medical Association, the Australian Pharmacy Guild, Medicines Australia and the private health insurance companies," he writes.

"The debate is not with the public about health policy and strategy; it is about how the minister and the department manage the vested interests."

Menadue says much of the policy skills in Canberra departments have been downgraded and policy work is contracted out to accounting and consultancy firms. Policy work within the government is now undertaken more in specialist organisation such as the Productivity Commission.

"Departmental policy capability has been seriously eroded. That is the real story behind the problems of the pink batts scheme."

As for the "inexperienced and young ministerial staffers", they're "much more likely to listen to vested interests".

On foreign affairs and internal security, the blog collection says we've become overdependent on the United States at the expense of our relations in our region. As Paul Keating once said, we should be "finding our security in, not from, Asia".

In dealing with the threat from terrorism, "a balance needs to be struck between national security and the freedoms essential for a civil society, including the humane treatment of refugees. The politicisation of security has arguably made us less safe."

On Medicare we're told it "has stood the test of time but it now represents the single biggest budgetary challenge and it is over 30 years since it has been seriously reviewed and reformed".

On superannuation, Andrew Podger, former head of various government departments and now a professor at the Australian National University's Crawford School of Public Policy, makes a plea for considered and balanced reform rather than piecemeal tinkering.

You'll go a long way before you find someone providing a more authoritative, independent and sensible commentary on budget repair and other fiscal matters than Mike Keating, former head of the Finance department and Prime Minister's and Cabinet.

In this book he has hardheaded things to say about the dream of lower taxation, which "has been embraced by all political parties without any evidence that, given our already low starting point, less taxation will in fact lead to higher economic growth, let alone pay for itself".

He quotes John Howard saying that tax cuts should be considered only "after you have met all the necessary and socially desirable expenditures".

All the evidence is that these spending demands, even if efficiently funded, are most unlikely to be fiscally sustainable without a modest increase in taxation relative to gross domestic product.

"Indeed, Australia already has lower taxation than almost any other advanced nation, but we aim to provide the same level of public services and welfare as the others," he writes.

"Thus the biggest challenge facing modern governments is the gap between expectations on them and their capacity to deliver.

"In these circumstances, encouraging unrealistic expectations of tax cuts is only making government more difficult."

Reading this collection of blogs leaves you with the impression the good bureaucratic advice our successive governments have needed to do a better job of running the country now resides outside the public service, in the minds of the retired bureaucrats who're from the days when they were expected to know about policy.

Wednesday, November 11, 2015

We can grow GDP if we stop growing natural resource use

Some things are more important even than the fate of the goods and services tax. A question I regard as just a tiny bit more significant to our future is whether we can continue increasing our population and material standard of living without doing irreparable damage to the natural environment.

Few of us noticed in all the excitement over tax reform, but last week we made a big step forward in answering this question. The CSIRO unveiled the results of a ground-breaking, two-year project – the Australian National Outlook report – in which it integrated a model of the economy with no less than eight models of different aspects of the global and domestic natural environment in which the economy exists.

So, is ecologically sustainable growth possible? Is it possible to "decouple" continuing economic growth from continuing environmental vandalism?

It depends on what you mean by "growth". There's enormous confusion on this point because what economists take the word to mean is not what scientists take it to mean.

What scientists mean by growth is growth in the "throughput" of natural materials and energy – using those resources to generate economic activity and, in the process, turning them into various forms of pollution and other waste.

They point out that such growth simply cannot continue indefinitely because the natural world – the global ecosystem – is of fixed size. And they have to be right because they're merely stating the first law of thermodynamics.

But that's not what economists mean by growth. They mean an increase in gross domestic product, most of which is cause by increased productivity (efficiency). It may or may not involve an increase in the economy's throughput of natural resources.

So what does the CSIRO's modelling say about whether we can continue to grow without inflicting further damage on the environment?

It says GDP can continue growing strongly, but throughput of natural resources can't. So the people who want continued growth in GDP win, but so do those saying ever-increasing use of natural resources must stop.

Since no one knows the future, CSIRO's economists and scientists ran through their super model 18 different scenarios covering different rates of growth in the global population, different degrees of global action to restrain climate change and a range of differing development in Australia and its economy.

All 18 scenarios project continuing strong growth in Australia's population and GDP out to 2050. But get this: only three of those scenarios also saw improvement or no further deterioration on the model's three key indicators of environmental health: emissions of greenhouse gases, water stress, and loss of native habitat.

As well, two of the three scenarios see no increase in the economy's annual throughput of natural resources, while the third projects a fall in material throughput of 38 per cent.

All this says ecologically sustainable growth and decoupling do seem to be possible, provided the world gets its act together.

The good news is that the model's results don't rely on "technological optimism" (don't worry, market forces will call forth a technological solution to every problem before the proverbial hits the fan) but nor do they require that we renounce our materialist ways and become greenie vegan mud-brick makers.

We don't need to do anything we don't already know how to do and, in many cases, have already begun doing. We just need to do a mighty lot more of it.

The bad news is that we can't do it on our own. To achieve improvement in the key environmental indicators and a fall in material throughput we need effective international action to limit the world's population to 8 billion in 2050 and limit global warming to 2 degrees in 2100.

This would require "very strong" global and Australian effort to reduce greenhouse emissions.

The two other environmentally not-so-bad scenarios – involving world population growing well beyond 8 billion and global warming limited to 3 degrees – would require "strong" global and Australian effort to reduce emissions.

Strong translates as a worldwide price per tonne of carbon dioxide emissions of $US30 ($42) in today's dollars; very strong translates as $US50 a tonne.

These world prices would be applied in Australia. But we'd have a comparative advantage over many countries that would reduce the carbon price's adverse effects on our economy: we could achieve up to half our required reduction in net emissions by "carbon sequestration" – reforestation of cleared land, either with one species of eucalypt (to maximise sequestration) or a range of eucalypts (to also restore native habitat).

At these carbon prices, our farmers could earn up to five times what they make from using the land to produce beef.

Our greenhouse emissions per person would fall from five times the global average in 1990 to below average by 2050.

Our biggest problem would be avoiding water stress, particularly because reforestation would add to the problem. The price of water for agriculture would be a lot higher and, in the cities, we'd have to do a lot more desalination and water recycling for industrial use.

I don't regard this as the last word on the subject. All modelling is far from infallible and this exercise is no different. The good thing is that a last we've made a start at reconciling our materialist ambitions with the constraints imposed by the natural environment we hope to continue living in.

Monday, November 9, 2015

Tax reformers forget budget repair

Don't say no one warned you. As finally the nation focuses on tax reform, something is quietly slipping out of our grasp: the return to a balanced budget.

How so? Short answer: an annoying little thing called opportunity cost. Long answer: tax reform and budget repair are, to a significant extent, in conflict. The more we get of one, the less we get of the other.

So which does the government, its big business urgers and most economists want more? The choice will be most excruciating for Treasury.

The first reason for doubting we'll ever see a return to structural budget balance starts with simple arithmetic. For tax reform to have no direct effect on repair of the budget, the total reform package needs to be "budget neutral": its net changes on the revenue side should exactly offset its net changes on the spending side.

But major, potentially unpopular tax reform doesn't work that way. In practice, governments need to minimise the number of net losers by giving away more than they take.

John Howard's package introducing the goods and services tax in 2000, for instance, was heavily budget negative. He'd taken the precaution of saving up, so to speak, to pay for disproportionate tax cuts by amassing huge bracket creep, having avoided tax cuts for five or six years.

Of course, he had the budget well back into surplus by then and could take the hit without causing concern.

Nothing about Malcolm Turnbull's rhetoric suggests he's headed for a budget neutral package. He's been assuring his right wing that the package won't involve any net increase in the overall tax take.

But if it's revenue neutral rather than revenue positive, that means it has to be budget negative.

Why? Because the package will need to compensate low-income earners via increased spending on pensions, the dole and family allowances.

And if the premiers aren't to oppose the reform package, the feds will need to pay a fair proportion of the GST proceeds to the states. This would represent a decrease in Tony Abbott's $80 billion in prospective budget savings from cuts to the states' grants for schools and hospitals, already in the budget's forward estimates.

The second reason for doubting the budget will ever be repaired is that much of the present deficit is structural rather than cyclical. Turnbull has been saying the budget will return to surplus once the economy gets back to trend growth.

Sorry, Malcolm, not right. By definition, to say we have a structural deficit – as Treasury does in each year's budget papers – is to say the budget will still be in deficit even when we've returned to the normal part of the business cycle.

Structural deficits are the cumulative effect of past unfunded decisions to cut taxes or increase spending. This may not have been obvious at the time if the economy happened to be booming, giving you a big cyclical surplus to hide your transgressions.

This is why so much of our present structural deficit is owed to the decisions made by the Howard government during the first stage of the resources boom, including the eight successive tax cuts and, notably, Peter Costello's unsustainably generous increase in superannuation tax concessions in 2007. Also, Howard's halving of capital gains tax in 1999 (which has done so much to fuel negative gearing).

Labor's unfunded spending on the national disability insurance scheme and the Gonski school funding reforms have added to the structural problem laid by the Coalition, though much of this spending is to come.

Apart from allowing bracket creep, the only way to eliminate a structural deficit is via explicit cuts in spending and "tax expenditures" (special tax breaks), and explicit tax increases.

With tax cuts and tax expenditures playing such a big part in creating the structural problem, to resolve to fix it solely via spending cuts is a recipe for failure. That's the lesson of last year's disastrous budget.

The obvious way to begin eliminating the structural deficit is to reverse at least some of the irresponsible tax expenditures that gave rise to it. However, if Turnbull summons the courage to act on super and capital gains, it's likely he'll use the proceeds to make his tax package look fairer, not to cut the deficit.

The third reason for doubting we'll ever see budget repair also concerns opportunity cost. Even a leader as popular as Turnbull has a limited supply of political credit to draw on.

The more points he uses on the unpopular elements of his tax reform package, the fewer are left to cover the unpopular measures needed to get the budget back to balance.

Saturday, November 7, 2015

CSIRO fills Treasury's gap on environment modelling

After Treasury's hopelessly inadequate attempt to peer into the future in its intergenerational report earlier this year, just look at the far more fair dinkum future-viewing exercise that CSIRO unveiled on Thursday.

Treasury's effort was little more than a propaganda exercise about the need to restrain government spending, and showed clear signs of government interference. It was widely criticised for purporting to tell us what could happen to the economy over the next 40 years while making no allowance for the effects of climate change and other environmental problems.

By contrast, CSIRO's peer-reviewed modelling exercise attempts to look at what may happen to the economy out to 2050, after accounting for the economic effects of climate change – and our efforts to reduce it – plus other environmental problems such as energy use, water use and use of other natural resources.

This attempt to integrate changes in the natural environment with standard economic modelling is a heroic effort, the first time to my knowledge it's been attempted for our economy.

It's contained in CSIRO's first Australian National Outlook report, but also reported separately in this week's issue of the prestigious scientific journal, Nature.

The project was directed by Dr Steve Hatfield-Dodds, a former Treasury economist now with CSIRO, with participation by another three economists and 13 scientists, mainly from CSIRO.

The question they sought to answer was whether the mounting ecological pressures in Australia can be reversed while our population continues growing and our material living standards continue rising.

To put it another way, can economic growth be "decoupled" from natural resource use and environmental stress?

The modelling takes a fairly conventional "computable general equilibrium" model of our economy, but surrounds it with eight other models of different aspects of the environment – global climate change and economic growth, water use, energy use, transportation, land use, material flows and biodiversity – which have effects on the economy.

But can any person or model accurately predict what will happen in the future? Of course not. So the exercise identifies 18 different plausible "scenarios" of how things may unfold and runs each of them through the nine-model set-up.

Each scenario combines differing global drivers of change with differing domestic drivers. The global drivers cover differing rates of growth in the global population by 2050 – it may grow to 8 billion, 9 billion or 11 billion – and differing rates of greenhouse gas emission.

Limiting global warming to 2 degrees above pre-industrial levels by 2100 would require "very strong" efforts to "abate" (reduce) emissions. Limiting it to 3 degrees would require either a "strong" abatement effort if the global population was allowed to grow to 11 billion, or a "moderate" effort if the population grew only to 9 billion.

That leaves "no abatement action", with the global population growing to 11 billion and global warming reaching 6 degrees. Gasp.

The domestic drivers of change cover differing degrees of improvement in agricultural productivity, differing land-use changes from the development of reforestation markets for sequestration of carbon dioxide or for protection of biodiversity, individuals' take-up of opportunities to use energy and water more efficiently, how much of our improving productivity we take as reduced working hours rather than higher real incomes, and how much of our consumer spending we devote to buying "experiences" rather than goods.

(Turns out those last two drivers made little difference to environmental outcomes, according to the model.)

It's assumed that Australia's abatement effort is at the same rate as the global effort. Up to half our net reduction in emissions is achieved by "carbon sequestration" – withdrawing carbon dioxide from the atmosphere and storing it in plants – achieved by reforestation of cleared land.

So, we build this amazing nine-model model, then run each of the 18 different scenarios through it. What results do we get?

In all scenarios, the economy and living standards are projected to grow strongly. The value of economic activity (gross domestic product) is projected to rise 10-fold over the 80 years to 2050 (the exercise actually starts in 1970, with actual data up to 2012).

This increase in GDP is driven by a 2.9-fold increase in population, leaving a 3.2- to 3.6-fold increase in GDP per person.

On some scenarios, net greenhouse emissions fall to zero or lower by 2040. From four times the global average today, our emissions per person could fall below the global average by 2050.

Apart from reforestation, emission reduction comes from reduced emissions (within Australia, not elsewhere) and from the economy's reduced resource-intensity (that is, fewer natural resources being used to generate each dollar of GDP).

National water extractions are projected to maybe double in 2050, but up to half this increase could be met by desalination in coastal cities and water recycling for industrial use.

Water stress – seen in rain-fed water use in water-limited catchments – improves or is stable in seven of the 18 scenarios.

Pressures on biodiversity (preservation of species) could also be reduced despite economic growth and increased agriculture. But carbon and biodiversity tree-planting could increase the pressure on river-based water systems.

Overall, 13 of the 18 scenarios show improvement in a least one environmental indicator, but only three – each requiring "strong" or "very strong" abatement effort and development of reforestation markets – show improvement in all three environmental indicators.

So the modelling suggests economic growth can continue without worsening – and even while improving – pressures on the natural environment, but only if we and the rest of the world greatly increase our efforts to reduce emissions.

Now, I should warn you that modelling exercises – economic and scientific – are always subject to limitations and open to criticism. They rely on many assumptions and are widely misused by vested interests.

I'm sure in 20 years' time, this CSIRO modelling will look very crude. Right now, however, it's a wonder of the modern world.

Thursday, November 5, 2015


Sydney, Thursday, November 5, 2015

Paul Samuelson, the famous American economist, is said to have remarked that the stockmarket has predicted nine of the past five recessions. I thought of that this week and decided the Canberra press gallery could top it: the gallery has predicted nine of the past two early elections. They were at it again last weekend, reporting that, with the Coalition now riding high in the polls, serious thought was being given to calling an election - per force a double dissolution - early next year. It was an unconvincing proposition and, perhaps fearing that election speculation wouldn’t help restore business confidence, Malcolm Turnbull quickly scotched it, saying we could expect the election to be when it was supposed to be, in September or October next year.

The sub-title of the book whose launch we’re here to celebrate is, Filling the Policy Vacuum. The media have an important part to play in filling that vacuum - and maybe in having helped to create it in the first place. At present, what’s filling the vacuum - that absence of serious and informed discussion about the many policy issues the government should be grappling with - is what’s called “race-calling” - who’s winning, who’s losing, who’s facing leadership rumblings from the backbench and who’s planning to call an early election.

The gallery loves writing this stuff - it’s much easier and more interesting than discussing policy issues. And the gallery has discovered their editors back at head office love it. It’s reporting politics as though it was a form of sport - my team versus your team, who’s winning on the league table and worries about Plugger’s groin and whether he’ll pull up by Saturday. For most of our lives the newspapers have faced ever-increasing competition, not just from rival purveyors of news - radio, television and now the internet - but, more significantly, from the ever-multiplying ways for us to spend our leisure time rather than sitting down and reading the paper. Perhaps unsurprisingly, the media have reacted to this growing competition from rival forms of entertainment by making their political reporting more entertaining; by more race-calling and less earnest discussion of policy choices.

I don’t happen to agree with this approach. For one thing, politics as a fifth code of football doesn’t have that many followers. Most of us in this room would be avid followers, but most people out of this room aren’t all that excited by it. It may well be that all the argy-bargy the media focus on actually turns voters off politics.

Nor do I accept that policy discussion is inevitably on the dry side. Policy can be interesting, provided the journos know enough about the subject, have the confidence to sort the wheat from the chaff and highlight the parts of the policy choice that touch on people’s lives. The real problem is that good policy reporting and discussion requires harder work, not to mention greater specialisation.

In Ken Henry’s introduction to this book’s collection of 48 short policy discussions by 31 contributors covering as many as 15 policy areas - with all those contributors being well-known and well-respected former bureaucrats or academics (none more so than the book’s two editors and most prolific contributors, John Menadue and Mike Keating) - Ken says he “can’t recall a poorer quality public debate, on almost any issue, than we have had in Australia in recent years”.

There may have been a worse time in the past but, like Ken, I can’t remember it. In this talk I could try to come to grips with all the pertinent and challenging things those many authors have to offer on those many problems we face at present, but I’ll content myself with saying a little more about how this policy paucity came about and how the vacuum could and is being filled.

I’ve already acknowledged the part the news media have played in creating the vacuum and filling it with dross. As Michelle Grattan wrote in a piece published on The Conversation website last Saturday (October 31), “if we are talking about improving and enhancing public policy and the debate around that, the media have a significant role to play. They provide prime routes by which information about policy is disseminated; they are also conduits for the ideas being thrown up from these other players”.

It’s easy - and probably correct - to attribute part of the legacy media’s deterioration in performance to their preoccupation with finding a continuing place in the world of the internet, increasingly accessed by apps on mobile phones.

But I want to make the point that, from a policy-debate perspective, digital disruption has brought pluses as well as minuses. People interest in finding thoughtful, well-informed, even expert policy discussion no longer have to rely on newspapers and magazines. They can find new sources of quality supply quite readily on the net. Chief among these is the aforementioned The Conversation. I think this is a wonderful development.

One of the problems with the policy debate has long been the paucity of the contribution to that debate by academics. The universities profess to want to contribute to the debate, but the plain face is their reward system effectively discourages it, overwhelmingly favouring research. Many academics don’t follow the policy debate; they write for publication in journals that aren’t much interested in practical, “applied” matters like policy discussion and, fearing criticism from their peers, they spend months perfecting an article before letting it see the light of day.

The genius of The Conversation is that it has reframed academic contribution to the policy debate as something the uni authorities smile on (because they fund the site) and as something that, because of the unavoidable time pressures, everyone accepts is quick and dirty, the very opposite to what a journal article is supposed to be. The proprietors of the site must have established for themselves a licence to extensively rewrite the turgid prose most academics have trained themselves to write.

Of course, The Conversation is just the biggest and most notable new digital contribution to the debate. Various local academics run their own blogs - John Quiggin is the oldest example - or contribute to high quality group blogs, such as Club Troppo and Core Economics.

Which brings us to blogs by former bureaucrats, the chief among which must surely be our own John Menadue’s Pearls and Irritations. All the pieces in the book are, in fact, invited contributions to the special series John and Mike Keating organised earlier this year on Fairness, Opportunity and Security. The 48 articles are still accessible on John’s blog, but as an oldie who usually prints off internet articles to be read on paper rather than screen, I hope this project of turning them into a book will make them even more accessible and more widely read. They certainly deserve to be.

In view of this policy vacuum needing to be filled, it’s really great to have John providing this new platform and encouraging former bureaucrats to use it. Never has their contribution been more needed. We independent media commentators do our best to evaluate the government’s performance, but there’s nothing like a former bureaucrat to be able to see through the smoke and mirrors and decipher the true position. I myself have been delighted to take full advantage of Mike’s superior understanding of budgeting and macro and micro-economic policy.

I should add that the Grattan Institute - itself composed mainly of former academics and bureaucrats - has made a useful contribution to filling the policy gap, as have the many former bureaucrats now kept busy in non-retirement at the ANU’s Crawford School of Public Policy - some of whom have contributed to this volume.

Since the extraordinary economic and political incompetence demonstrated by the Abbott government’s first budget, I’ve spent a lot of time thinking about who was responsible for its failure and the huge damage this did to the Abbott government’s policy performance in other areas. Was it the econocrats in Treasury and Finance, the people at the top of the spending departments, the government’s youthful private office advisers, the bum steer provided by the strangely constituted commission of audit (which was pretty much contracted out to the Business Council), or just the manifest personal deficiencies of Tony and Joe.

I’ve come to the conclusion that poor advice from the econocrats and the department heads can’t be absolved from some share of the blame. But this can be traced back to the fault of the politicians - Rudd and Gillard as well as Howard and Abbott. The shiny-bums are an easy target for all politicians and, in the case of the Coalition, a very senior bureaucrat told me that they hold public servants in contempt. I believe that year-upon-year of ever-higher “efficiency dividends” has robbed the econocrats and the spending departments of much of their ability to provide their political masters with good policy advice.

The new practice of new Coalition governments beginning their terms by arbitrarily sacking a number of department heads must surely be designed to encourage the others not to provide frank and fearless advice. The Liberals’ “revealed preference” seems to be that they don’t want policy advice from bureaucrats. We’ll make the policy, you just implement it.

I know it’s easy to develop quite unrealistic expectations of what Malcolm Turnbull even wants to change, let alone will see his way clear to. But, even so, I’m sure he must be better than this. He’s too smart not to want good quality and frank advice from his bureaucrats, and I think he’ll want a high quality, intelligent public debate about policy options.

In Michelle’s Conversation piece that I referred to earlier, she implied that one reason for the gallery’s less than inspiring performance on policy issues is the actions of governments of both colours and over many years in discouraging contact between bureaucrats and journalists. It wasn’t like that in the 1970s when she - and, a little later, I - first went to the gallery.

Michelle suggests that the gallery’s coverage of policy issues could be much improved - to the advantage of the government of the day - if contact between the gallery and fairly senior bureaucrats was restored. As she stresses, this wouldn’t be about leaks, but about officials with expertise providing journos with the context and detail they have at their fingertips.

If any politician is able to see the sense in such a proposal, it ought to be Malcolm.


Wednesday, November 4, 2015

Why we're sure to be voting on a rise in GST

About a year ago, I began confidently predicting the Coalition would not be going to next year's election with any proposal to increase the goods and services tax. I've been tardy in advising you that, with the removal of Tony Abbott and the ascension of Malcolm Turnbull, that prediction has become, as George W. used to say, inoperative.

Indeed, I now confidently predict the Coalition will be seeking the voters' agreement to an increase in the GST.

Why the reversal? Turnbull doesn't have much choice but to run with a GST increase for pretty much the opposite reasons that Abbott had little choice but to avoid one.

Abbott and his treasurer, Joe Hockey, would love to have championed a GST rise – and, early in their term, fully intended to do so – but their disastrous first budget, with its blatant unfairness and broken promises, robbed them of their popularity, authority and trustworthiness.

They repeatedly demonstrated their inability explain complex and controversial policy proposals.

But the government's big-business backers – not to mention most economists – have convinced themselves the only cure for the sluggish economy is major economic reform, and top of their list is a cut in the rate of company tax, plus a cut in the top rate of personal income tax.

This is why they became so dissatisfied with Abbott and Hockey, and so expectant of better things from one of their own, Turnbull.

The whole country knows Turnbull will be a better manager of the economy than Abbott and that if this silver-tongued barrister can't "sell" economic reform, no one can.

So great is the confidence in the confident Turnbull that the best way for him to stumble would be to baulk at this challenge.

Trouble is, by the time he's knocked tax reform into political shape, it will have fallen well short of its proponents' grand vision, won't deliver the promised economic benefits and won't make much difference to anything, apart from making the tax system less fair.

Right now, Turnbull is grappling with the desired shape of the GST increase. My guess is he'll definitely want to increase the rate of the tax, and won't go through all the angst for a piddling increase to 12.5 per cent. No, he'll go all the way to 15 per cent.

Broadening the tax's narrow base is more problematic, as the academics say. My guess is he'll avoid the practical minefield of extending the tax's coverage to health and education (even though taxing private health insurance and private schools would do much to reduce the tax's regressiveness​), but may include financial services.

His big temptation will be to tax fresh food but, though this would greatly increase his takings, it would also greatly increase the tax's regressiveness (because low-income households devote a much higher proportion of their budgets to food than high-income households do) and thus require much of this gain to be returned as "compensation", while adding much agonising and indignation from the elderly.

Of course, the GST increase will just be part of a much bigger package of tax reforms. Since the object of the exercise will be to change the "mix" of taxation – increasing indirect taxes on consumer spending while reducing direct taxes on income – it will include big tax cuts.

Turnbull will learn from his predecessors' blunder and ensure his reform package looks fair by including imposts aimed mainly at high-income earners. If he decides to cut the top rate of income tax – benefiting just the wealthiest 3 per cent of taxpayers – he'll probably include a crackdown on superannuation concessions and discounted capital gains tax favouring the well-off.

He'd also want to throw in abolition of some inefficient state taxes, such as the stamp duty on insurance policies.

He's making it very clear that low- and middle-income families would be protected from the effect of the higher GST by adequate compensation, in the form of special increases in pensions, dole payments and family benefits. People on low wages would be compensated by tax cuts.

But just because Turnbull has the smarts, political credit and credibility to raise the GST and hope to keep his job, this doesn't give him a magic wand to wave away the iron laws of arithmetic.

The sad truth is that the untiring advocates of a higher GST have plans to spend the proceeds many times over. Big business wants to devote the proceeds to covering the cost of cutting the rate of company tax.

The nation's grossly over-taxed chief executives want to use the proceeds to cut the top rate of income tax – all to produce a flowering of innovation and agility, naturally.

Then there's the Treasurer and his department, who profess to want to use the proceeds to counter the effects of bracket creep on everyone paying less than the top rate.

And, finally, there are the premiers, who think they own the GST and want to use the proceeds to cover the ever-rising cost of their spending on schools and hospitals. In principle and in political reality – although not strict legality – the premiers have a veto over any increase.

As ever, they'll go along with the deal once they've extorted enough moolah from the feds. Right now, they're in negotiating mode.

But not to worry. St Malcolm has promised to square the circle.

Monday, November 2, 2015

Econocrats propose same old answer to all problems

If Malcolm Turnbull wants policy reforms that make the economy more innovative and agile, he should think long and hard before accepting advice from the economists in Treasury and the accountants in the department of Finance.

If you want innovation and agility, the last people to whom you should look for help are the two professions that, in their approach to problems new or old, demonstrate minimal innovation or mental agility.

I wouldn't want to call them insane, but they certainly recommend the same solutions over and over, while expecting different results.

The trouble with both professions is that their expertise is so narrow: they know a lot about just one aspect of the problem and little about all the other aspects, which they tend to ignore - while failing to warn their clients to match their advice against the advice of experts in other areas.

In the case of economists, they know what the economy needs, but they don't know much about what the economy needs and, thus, how to go about getting it.

For instance, economists see consumption as "the sole end and object of all economic activity". So they're experts on consumption, are they?

Well, no, not really. They couldn't, for instance, tell you how to maximise the utility you derive from your spending on consumption. Not their department. Better to ask a psychologist.

Economists know that improving productivity is the key to achieving faster economic growth and ever-rising material living standards. In fact, in the long run productivity is "almost everything".

So, could you give us a list of 10 things we could do to lift productivity? Well, no, not really. We don't actually know much about how you get productivity, we just know it's a great thing to have.

Of course, we do know a key source of productivity improvement is technological advance. Great, so how does technological advance work? Sorry, we haven't studied it much. We did have a go at developing an "endogenous growth theory" in the 1980s, but we soon gave up.

So what exactly is economists' area of expertise? They'd never admit it, so I'll tell you: prices. They know heaps about how the price mechanism works (given a host of mainly unrealistic assumptions), but not much else.

To make it sound sexier they may tell you economics is "the study of incentives". But in the economists' lexicon, incentives is just a synonym of prices. That's because economics pretty much ignores anything that can't be quantified, so the only incentives economists are conscious of are monetary incentives.

This assumption - that the power of monetary incentives is quite unaffected any other motivations (e.g. Turnbull only knocked off Tony Abbott because prime ministers are paid more than ministers) - does much to explain why the solutions economists propose often work so badly, with so many "unintended consequences".

Note that, in the mind of an economist, things like taxes and wages are just prices. This does much to explain economists' apparent obsession with taxation. It's a government-controlled price that seems to have much to do with the things politicians worry about these days.

It's a way for economists to appear to have useful advice on problems they don't really know much about.

Q: How should we encourage people to work more? A: cut the company tax rate and the top rate on individuals.

Q: How should we encourage people to save more? A: cut the company tax rate and the top rate on individuals.

Q: How should we encourage people to invest more? A: cut the company tax rate and the top rate on individuals.

Q: How should we encourage innovation? A: cut the company tax rate and the top rate on individuals.

Q: How can we make the economy more agile? A: cut the company tax rate and the top rate on individuals.

In sum, their preferred advice on such questions is: get the [monetary] incentives "right" and stand back.

Anything more specific to suggest? Yes, prime minister. Increase the tax incentives for spending on research and development. Give more money to scientific outfits like the CSIRO.

But haven't you guys been advising governments for years to keep cutting R&D tax breaks and money to CSIRO? Yes, prime minister, but that was when we wanted to cut the budget deficit and didn't care how we did it. Then, we didn't give a stuff about innovation and agility.

How come your advice on tax reform invariably favours high income-earners? Because when you're giving advice on matters you don't know much about, it's much less critically scrutinised when it happens to favour the rich and powerful.

Sunday, November 1, 2015


Talk to group in Maitland, NSW, November, 2015

Particularly for those of us of a progressive or left-of-centre perspective, it’s easy to doubt whether democracy still works in the 21st century.

You look around and see so much you don’t like. You see governments - even Labor governments - pursuing policies that seem to be always giving big business what it wants and disadvantaging ordinary people.

  • Making so-called free trade agreements in great secrecy - clauses that allow foreign businesses

  • Planning to increase the regressive GST so as to finance a cut in the rate of company tax and probably cut the top personal tax rate

  • Allowing the incomes of top executives and others in the top 1 pc to grow far more rapidly

We see all this and we wonder whether we still live in an effective democracy.

I believe we do. Democracy still works - when enough of us want it to.

But let’s not delude ourselves about how democracy works.

Democracy was never designed to deliver perfection.

It doesn’t promise that no government ever does anything we personally disapprove of.

It never gives any individual exactly what they want it to. It’s designed to give most of us a mixture of good and bad we’re prepared to live with.

In particular, it doesn’t give any of us a world that never changes. The world we live in is continually being changed by factors beyond the control of any democratically elected government. Many of these factors originate beyond our shores.

The biggest single factor that’s rapidly changing our world is technological advance. Most of us like most of the technological change that comes into our lives. No elected government is going to try to halt technological change. With things like the internet, it wouldn’t get far if it tried.

Consider digital disruption. It’s caused massive and unpleasant change in various industries - the music industry, movies, book-sellers, it’s ripping the heart out of newspapers, it will hit retailers hard as ecommerce grows, it’s starting tear into the taxi industry, Airbnb is taking business away from hotels. And digital disruption has much, much further to run. It’s cost thousands of workers their jobs.

And yet the great majority of the customers of these industries are left better off by digital disruption - which is why it’s happening and why no democratically elected government will ever seriously try to stop it.

Democracy is democracy. It’s government by the majority for the majority. So it gives us governance most of us are willing to cop.

You think big business is being allowed to ride roughshod over the rest of us and it’s all terribly unfair? Sorry, you may be right but not enough people agree with you.

Democracy brings about or allows changes you may not like, but plenty of others do:

  • Harsh treatment of people who arrive by boat

  • An end to the carbon tax that was adding too much to the cost of living

Democracy doesn’t protect voters who go to sleep on the job. Who aren’t sufficiently interested to pay attention, don’t notice what’s being done to them and don’t make sure they get all the facts.

The way a democracy works is one person, one vote.

The way a market economy works is one dollar, on vote. Those who have more dollars end up with more of what they want.

You may think that gives the rich and powerful a built-in advantage in any democracy.

That’s true - but when the chips are down, I’d still put my money on democracy winning the day.

The trick is that politicians care most about votes. If they don’t get enough votes they’re out on their ear.

They care about dollars only to the extent they think they will help them buy votes. Sometimes that works, but in the end it doesn’t.

Consider the GST tax package. No matter how much Malcolm would like to deliver for his business mates, his primary concern will be to make sure he gets re-elected. To ensure he does, he’ll end up with a package that, even though you don’t like it, business won’t like much either.

In recent times we’ve seen two powerful indications that votes beat dollars. Campbell Newman in Queensland. The first-term Liberal government in Victoria. Murdoch press.

Is it all terribly unfair? I don’t think it can be. Why? Because so few of the people you believe are victims are dissatisfied enough to bother voting against it. That’s actually why the two parties don’t give voters a very wide choice - they don’t think more extreme policies would win them many votes.

My final point is the one Winston Churchill so famously made: what’s the alternative you’re proposing?