Saturday, December 31, 2016

To what do we owe the Industrial Revolution?

One of the small pleasures of my year was watching the deft political manoeuvrings of Thomas Cromwell in the TV miniseries of Hilary Mantel's Wolf Hall.

Of course, this has nothing to do with the economy – or does it?

I've just been reading a paper by three economic historians, Monks, Gents and Industrialists, arguing that an important reason why the Industrial Revolution of the late 18th century began in England, and in particular parts of England, was the long-run consequence of Henry VIII's dissolution of the monasteries between 1532 and 1540.

Henry's right-hand man in orchestrating the dissolution was Thomas Cromwell.

The economists are Leander Heldring, of Oxford University, James Robinson, of the University of Chicago, and Sebastian Vollmer, of the University of Gottingen in Germany. Their paper is published by America's National Bureau of Economic Research.

We owe today's economy to the two centuries of economic development precipitated by the Industrial Revolution, a period of radical technological innovation beginning in the 1760s.

It involved the replacement of hand tools with power-driven machines, and the shift of production from artisans' homes to factories.

The initial changes were in textile manufacture and metals, using new forms of inanimate power such as the steam engine and new methods of transportation, such as the railway.

The newly ubiquitous form of energy was coal – the start of our ill-fated love affair with fossil fuels.

There's less agreement among historians on why the Industrial Revolution started in England. Some give the credit to Britain's superior economic and political institutions. Others see it as a consequence of various "economic shocks", such as the Black Death of the mid-14th century or the expansion of Atlantic trade.

These led to changes in England's social structure, to political conflict in the 17th century, particularly the English civil war of the 1640s, to the Glorious Revolution of 1688, in which William of Orange seized the English throne from James II and, ultimately, to favourable changes in economic institutions.

The famous English historian Richard Tawney argued that the dissolution of the monasteries caused a change in the rural social structure, which led to the civil war.

Later scholars have discounted this, but our authors argue the dissolution helped bring about something much bigger, the Industrial Revolution.

As part of Henry's break with the Pope – which happened at the time of the Protestant Reformation in other parts of Europe – parliament first decreed that the Catholic monasteries' tithes be paid to the king rather than Rome, then that the monasteries be dissolved, with their lands expropriated by the crown. The king was declared head of the Church of England.

In 1530 there were about 825 monasteries in England and Wales, housing about 10,000 people. The term "monasteries" includes nunneries, friaries, abbeys and priories.

Aside from maintaining property and collecting rents, the monks engaged in prayer and singing for the local community, were active in education and were expected to provide food and lodging to travellers and distribute alms to the poor.

The church is thought to have held between a quarter and a third of all the land in England and Wales.

Henry gave away some of the expropriated land – including to Thomas Cromwell – but sold most of it. Two-thirds had been sold by 1547 and most of the rest by 1554, during the reign of Edward VI.

A key part of the authors' thesis is that most of the land was sold to the "gentry" – all non-noble landowners with sufficient land or wealth to put them above the yeomen farmers.

It's estimated that the gentry's share of English land rose from a quarter in 1436 to about half in 1688. What Tawney called "the rise if the gentry" mattered because they tended to be more commercially minded rural entrepreneurs.

The authors hypothesise that, in parishes or counties where the gentry rose more, and where commercial farming was more advanced, the gentry would be involved in other activities which would ultimately coalesce into the Industrial Revolution.

Three mechanisms could have connected the gentry to industrialisation. First, they had the vote, were able to sit in parliament and to lobby for legislation favourable to their economic interests.

Second, it's plausible the gentry were part of "proto-industrialisation", where the necessary conditions for industrialisation were established. There are many case studies of such things as gentry establishing coal mines on their properties.

Third, to the extent that the gentry were entrepreneurial commercial farmers they would have been more innovative and productive, and this "agricultural revolution" could have directly stimulated the Industrial Revolution.

But the endangered species of economic historians isn't allowed just to think up plausible theories about the past. Academic economists' obsession with mathematics means they have to seek empirical evidence for their theses by using fancy statistical techniques to find correlations between whatever "data series" they can find.

The authors digitised the 1535 Valor Ecclesiasticus – a census of the monasteries' incomes, ordered by Henry – and compared it with the 1838 survey of textile mills, as well as figures from the British census of 1831 showing the proportions of the labour force engaged in manufacturing, retail and agriculture.

They showed that the monastic income in a parish in 1535 was positively and significantly correlated with the presence of a textile mill in the parish 300 years later. Monastic income was also correlated with the proportion of the labour force in manufacturing and retail 300 years later.

They then used a census from 1700 showing the number of gentry in each of 24,000 towns and villages. Again, a good correlation with the distribution of monastery incomes 165 years' earlier.

And they used other figures to show monastic income is correlated with the number of agricultural patents registered in a parish between 1700 and 1850, implying the dissolution may indeed have led to greater innovation.

So, thanks for your help, Thomas.

Wednesday, December 28, 2016

How to get more enjoyment from the time available

I don't know about you, but it's at this time of year, when the Christmas rush is over and things slow down – even for those who are "working through" – that I get a bit more philosophical, a bit more reflective.

What exactly did I achieve last year? Is next year going to be all that different? What's the point of working so hard? How can I find a better balance between work and play?

To tell you the truth, I'm divided between all my old professional ambitions and a desire to slow down, smell the roses and have more fun.

Of course, one of the key lessons of economics is that we're often faced by conflicting but desirable objectives, and the answer is to find the best trade-off between them. The particular combination that yields most "utility" (aka happiness).

Unfortunately, that's about as far as economists' advice goes. Fortunately, psychologists' advice is a lot more practical.

Economists are big on working to make money, then using the money to buy the things that make us happy. Which things, exactly? Who knows? Economists cop out at this point by assuming you know what things make you happy.

Psychologists assume nothing, but conduct studies and experiments to see which things make us happiest and whether we always know to pick them.

Often we don't. Some years back I wrote up the recommendations of three North American psychologists in their paper, If money doesn't make you happy then you probably aren't spending it right.

Their advice included spending on experiences rather than objects, spending on others rather than yourself (eg Christmas) and on small pleasures rather than big luxuries.

Research shows that small pleasures – such as a cold beer on a hot day or, for my family, a hot cup of tea on a cold day – are some of life's most "salient" (noticeable) instances of happiness.

But soon after, three marketing academics, Jennifer Aaker, Melanie Rudd and Cassie Mogilner, published a complementary paper, If money does not make you happy, consider time.

Ah yes, time. One of the most valuable commodities we possess, but often spend unwisely. We work less efficiently than we could (guilty) and waste too much of our leisure time sprawled in front of the box watching reruns of Midsomer Murders (ditto).

Time tends to be laden with personal meaning – we live through it, after all – compared with money which, at best, contains potential. And time fosters interpersonal connection.

Since both personal meaning and social connection have been found to be critical to happiness, for individuals to consider how they spend their time ought to be important in their efforts to "solve the happiness puzzle".

The authors' first suggestion is to spend time with the right people. That doesn't mean cosying up to Malcolm and Lucy, it means that social leisure activities contribute more to happiness than solitary ones.

People who engage in social activities more frequently, experience higher levels of happiness than those who engage less often.

Whatever the activity, you usually enjoy it more if you do it with other people.

But it's not only whether you spend your time with others, but who the others are. More satisfaction comes from spending it with friends, family and significant others (or "the wife", as we probably should revert to saying during the Trumpocene) than with bosses and co-workers.

That's no doubt true but, since most of us have little choice but to spend much time with workmates, it makes a lot of sense to turn workmates into friends whose company we enjoy.

The authors say two of the best predictors of people's general happiness are whether they have a best friend at work, and whether they like their boss.

As the quality of workplace friendships increases, so do happiness and productivity, studies suggest.

The authors' second suggestion is to spend your time on the right activities. Regular checking by testers shows that hanging out with family and friends comprise the happiest parts of the day, whereas working and commuting make for particularly unhappy portions of the day.

But, again, if you can possibly wriggle your way into a position where you enjoy your work, you'll do much better in the happiness stakes.

Third suggestion is to enjoy the experience without spending the time. Neurological studies show people get much pleasure merely from thinking about activities they find pleasurable.

You can get a lot of pleasure from reading up on and planning a holiday even if, for whatever reason, you end up putting it off.

You can derive pleasure from window shopping, and the pleasure gained from shopping for a dress may exceed the pleasure from actually acquiring the dress, they say.

But the authors' next suggestion is roughly opposite to the previous one: expand your time. Rather than spending a lot of time salivating over future purchases or adventures, focus on "the now".

One possible benefit from being present-focused is that it slows down the perceived passage of time, allowing people to feel less rushed.

In one study, people instructed to take long, slow breaths for five minutes not only felt there was more time available to get things done, but also perceived their day to be longer.

Let me wish that 2017 is a year in which you perceive yourself to be less rushed.

Saturday, December 24, 2016

We're on the way to peak everything

Some economists worry the world economy isn't growing fast enough. It's slowing down and reaching the point of "secular stagnation".

On a very different wavelength, however, environmentalists worry that if the world economy keeps growing the way it is, it won't be long before we run out of the natural resources on which that growth depends. Whoops.

But if all that's a bit heavy for the holiday season, here's something lighter. Remember all that crazy talk a few years back about the paperless office? What a joke.

Then there was peak oil. Whatever happened to that looming disaster?

If any of those possibilities piques your interest, I have news - courtesy of an essay by Professor John Quiggin, of the University of Queensland.

Quiggin thinks the paperless office is on the way, especially because the world has already reached "peak paper".

Despite continuing economic growth, peak paper was reached in 2013. "Global paper production and consumption reached its maximum, flattened out, and is now falling," he says.

Until relatively recently, the growth and spread of information was directly linked to the growth in paper, books and newspapers.

The closely related information revolution and digital revolution have broken that link. Businesses and governments don't print reports, they just put them on their website. We read e-books and online newspapers.

Banks and businesses want to stop sending us statements and bills through the post. If we hold out too long, they impose a fee for continued paper statements.

As for peak oil, Quiggin says that, in terms of oil consumption per person, the world reached it in 1979.

"In the developed countries, the decline in oil consumption per person has outpaced population growth, with the result that total consumption is declining. The average person in a developed country now uses less oil than her parents did 40 years ago," he says.

Why has this remarkable change attracted so little notice? Partly because much of the reduction in energy use has taken the virtually invisible form of improvements in energy efficiency. Both industrial processes and household appliances use far less energy than they used to.

But also because, until fairly recently, the main substitutes for oil have been other fossil fuels, such as coal and gas. Only in the past 10 years have renewable energy sources, especially wind and solar, begun to play a significant role, he says.

Peak coal has already arrived in the developed world. Coal consumption has fallen substantially in the US and Europe, and is set to fall further.

Until recently, the decline in fossil-fuel use in the developed world has been more than offset by rapid growth in the developing countries.

But even China - the planet's largest coal consumer by far - has changed course. Beginning with Beijing, it has begun closing down all the coal-fired power stations near major cities.

"In fact, China reached peak coal in 2013, at the same time as it reached peak paper," Quiggin says.

As for peak steel, it's different. Steel lasts a long time and can be recycled almost endlessly, but demand for it is finite.

In developed countries, the stock of steel reached about eight tonnes a person decades ago, he says, and has remained stable or slowly declining since then.

"With the stock of steel on a gently sloping plateau, the need for more can be met almost entirely by recycling scrap, rather than by burning coal to smelt iron ore in blast furnaces.

"The result has been described as a 'circular economy'. When this arrives, peak steel will have been reached."

All this has happened while economic growth has continued and living standards have risen.

Economists have been saying for years, particularly in the developed world, that growth is becoming "weightless". The part of the economy that's growing isn't goods - things you can drop on your toe - but services: people doing things for people, whether fixing their health, teaching them nuclear physics or waiting on their table.

With an ever greater proportion of gross domestic product - the quantity of goods and services produced in a period - accounted for by services, economic growth becomes ever less dependent on the increased use of natural resources.

Over the long term, growth in real GDP comes less from the use of more raw materials, human labour and man-made machines and structures and more from improved "productivity" - greater efficiency with which those inputs are transformed into outputs of goods and services.

What drives productivity improvement? Advances in technology and accretion of human capital. That is, the growth and spread of knowledge and information.

But an information-driven economy is very different from the one we've become used to since the industrial revolution, one driven by the use of natural resources to produce goods plus a few conventional services.

Natural resources are finite. If you want to use my coal or paper you must pay me (they're "excludable"). Any coal or paper you use can't be used by someone else (they're "rivalrous").

This makes economic growth relatively easy to measure. But knowledge and information are opposite to natural resources: they're often freely available (non-excludable) and my knowing something doesn't stop you knowing it, too (non-rivalrous).

What's the difference between a taxi and Uber? Information. What's the difference between renting a hotel room or self-catering accommodation and Airbnb? Information.

A knowledge and information-driven economy is one whose continuing growth makes less demands on the natural environment than many scientists and environmentalists imagine. That's particularly true as we move to renewable energy.

But a knowledge and information-driven economy is harder to measure, especially using the metrics (GDP) we developed to measure a raw materials and goods-based economy.

We're now in a world where GDP is going one way and raw-materials use is starting to go the other way.

That's why Quiggin doubts that world economic growth is grinding to a halt.

Wednesday, December 21, 2016

Why I wish we'd had our credit rating downgrade this week

You can tell by when a government releases its midyear budget update how well it's going with the budget. If it's doing well, it publishes as early in December as possible.

If it's doing badly, it publishes as close to Christmas as it thinks it can get away with, when normal people are busy with parties and preparations and not paying much attention.

This year we got the update just six sleeps before Santa's arrival. Draw your own conclusions.

And this year the government was worried, we're told, that the continued slippage in its efforts to repair the budget would prompt the credit rating agencies to downgrade our AAA status.

Labor was already salivating at the prospect, with finance spokesman Jim Chalmers confidently predicting a downgrade would "smash confidence in our economy" and "push up borrowing costs for households and small businesses".

You beauty! If that doesn't improve Labor's chances of beating the Coalition at the next election, what will? A little damage to the economy in the meantime? A price Labor would be happy for us to pay.

In the event, however, all three ratings agencies announced the update had done nothing to change their views.

But the government isn't off the hook. The most aggressive publicity seeker of the three, Standard & Poor's, didn't confirm our AAA rating, it said the update gave it no reason to change its "negative outlook" for that rating.

So the agency's supposed fiscal sword of Damocles remains hanging over Scott Morrison's head at least until the budget in May.

To tell you the truth, I'm sorry it didn't fall this week. That's not because I bear the government any ill will, but because the sooner we're downgraded, the sooner the public will realise there's little to fear from a downgrade. The ratings agencies are toothless tigers.

In any case, there is no good reason any sovereign Australian government – federal or state – should allow a few American for-profit businesses to dictate how much it should or shouldn't borrow (nor engage in hugely expensive ways of disguising the true extent of its liabilities).

The ratings agencies' credibility has been destroyed by their part in the global financial crisis. Not only did these all-wise experts fail to see it coming, they contributed to the conflagration by awarding AAA ratings to the promoters of "collateralised debt obligations" – for the small fee – that soon turned into "toxic debt".

It's long been questionable whether the agencies were leaders or followers in identifying the risks attached to the bonds issued by businesses and governments, but since the GFC there's little doubt the financial markets don't need their advice.

When Standard & Poor's downgraded US government bonds in 2011, the financial markets took no notice and the two other agencies left it hanging out to dry.

S&P downgraded Greece's government bonds only months after its budget cover-up became public in 2009.

All three agencies downgraded Britain's bonds immediately after Brexit, but market yields (interest rates) on those securities actually fell.

So it's not at all clear that a downgrading of our credit rating would do anything much to increase the interest rate at which our government can borrow.

And while it's technically true a downgrading of Australia's "sovereign" credit rating would flow on to the ratings of our banks, it's not clear this would increase their borrowing costs abroad, nor that there would be any flow-on to home buyers and small businesses.

While Labor's Chalmers was telling anyone who'd listen of the disaster about to befall everyone with a mortgage, the chief executive of ANZ Bank, Shayne Elliott, was telling his shareholders that a downgrade had already been priced into the funding costs for Australian banks.

Should the banks actually pass on that increase on to their customers, it would tell us less about the Turnbull government's budget failings than about the failure of successive governments – Labor included – to do enough to encourage greater competition between the big four banks, generous party donors that they are.

It suits neither the government nor the opposition to admit that the rating agencies' pressure on us to cut government spending is diametrically opposed to the advice we're getting from the two genuine international economic authorities, the International Monetary Fund and the Organisation for Economic Co-operation and Development.

Their advice is that, with our economy weaker than it should be, we still have plenty of "fiscal space" to strengthen the economy by borrowing to finance increased spending on worthwhile infrastructure.

All this is why I say that, these days, the economic significance of our credit rating is long gone.

It retains much political significance, however.

Governments – federal and state – still live in fear of a downgrade simply because they know their political opponents would parade this as a disaster for the government, the economy and public and private borrowers, as well as objective, authoritative proof that they are utterly hopeless economic managers.

Credit ratings are now little more than something the politicians use to slag each other off.

This is why I'm sorry we weren't downgraded this week. Only when the public experiences the ratings agencies' inability to have much effect on the interest rates we pay will they lose their power over our governments, and the pollies lose credit ratings as a political football.

Tuesday, December 20, 2016

Party blame-laying conceals budget truths

Don't believe anything any politician on either side says about the mid-year budget update and the expected further deterioration in the budget deficit it reveals.

And don't let speculation about whether the government will or won't lose its AAA credit rating worry you.

These days, our credit rating is little more than something for the politicians to use to slag each other off. Its economic significance is long gone.

According to Treasurer Scott Morrison, the government's long and unsuccessful struggle to get the budget back to surplus is all Labor's fault, first because of the terrible mess it left when it lost office and second because of its refusal to support many government savings measures in the Senate.

According to Labor, the Coalition's been in office for more than three years, during which time things have got worse rather than better, and it has no one to blame but itself.

In truth, neither side is as bad as the other side claims, but each is more at fault than it is prepared to admit.

It's true Labor left office with the budget in bad repair. It had two big new policies - the national disability insurance scheme and the Gonski schools funding scheme - for whose rapidly growing cost it had made quite inadequate provision.

But it is equally true that the Abbott government's first act was to make the budget worse by abandoning various taxes and tax savings measures it didn't agree with.

Morrison speaks at length about the government's efforts to "repair" the budget, but the truth is that, since the rejection of the government's first budget by the public and the Senate, it has made no further effort to improve the budget balance, either by net cuts in government spending or net tax increases.

When Morrison speaks about all the spending cuts he has succeeded in putting through, and all those Labor has helped to block, he hopes you won't realise that their purpose was merely to stop the government's new spending decisions from adding to total spending.

That is, he has limited himself to trying to stop government spending getting ever greater. He hasn't been trying to make it smaller.

It is true, of course, that Labor has blocked many of the government's proposed spending cuts.

But to imply, as Morrison and others argue, that Labor has a moral obligation to pass all the spending cuts the government proposes, is to absolve the government of any obligation to propose savings the Senate might regard as sharing the burden of budget repair fairly between the haves and have-nots.

In fairness, the further deterioration in the budget outlook revealed in the up-date arises almost wholly from slower than expected growth in tax collections, particularly the pathetically slow growth in wages, which is not of the government's making.

Labor refuses to accept this "excuse" as payback for the Coalition's refusal to accept Labor's "excuses" when similar revenue setbacks occurred while it was in office.

This is the point being missed in all the blame laying: the main reason successive governments have had so little success in reducing the deficit is the economy's weak rate of growth since the resources boom started busting in 2011.

Some may think the economy's continuing weakness should not inhibit the government's willingness to slash and burn. Not me.

Monday, December 19, 2016

Mining makes pollies confused about demand and supply

Since almost all of us have lived in a market economy all our lives, you'd expect the effects of supply and demand on price would be well understood, particularly by anyone who managed to get themselves into Parliament.

In fact, however, our politicians on both sides have terrible trouble working out how supply works. Sometimes they tell us increasing supply will put downward pressure on price and sometimes they tell us it won't.

Turns out they're wrong on both counts.

When it comes to natural gas, Industry Minister Greg Hunt – like his predecessors Ian Macfarlane and Martin Ferguson who, purely by chance, have since gone on to jobs lobbying for the mining and gas industries – tells us the solution to the high price and looming "shortages" is for the Victorian and NSW governments to give gas companies free rein to do their fracking wherever they choose on the states' farmland.

Adding to the eastern states' production of coal seam gas would increase supply and thus put downward pressure on gas prices and avert the risk of shortages, they tell us.

This would be true if Australia – strictly, our eastern seaboard – had a closed market. If there was no international trade in gas.

But that's the trick the pollies and the business interests they want to help don't want to draw attention to.

There's been little change to the eastern states' demand for gas, nor decline in the supply of gas from Australian gasfields.

What's changed is the decision of our governments to allow foreign investors to set up several gas liquefaction plants near Gladstone in Queensland.

By doing so they opened a link between our closed gas market and the world market, where the world price of gas just happens to be a lot higher.

The inevitable result is our wholesale gas price has doubled to reflect the world price, our manufacturers are claiming to be "uncompetitive" at such a price and people are claiming to see shortages looming.

(As is typical in a resources boom, when our politicians see their job as complying with every demand coming from the miners in their greed-driven frenzy, we allowed too many liquefaction plants to be built and now none of them is making money. But that's a separate stuff-up.)

The point is, for as long as our governments allow local gas producers to charge us the world price (which I think they should), no amount of additional coal seam gas production would be sufficient to lower that world price.

Federal pollies of both colours bang on about reducing the restrictions on fracking because they're doing the bidding of their mates/generous party donors/future employers in the gas industry and because they want to draw attention away from the truth that they allowed domestic gas prices to rise and don't want to do anything to cut them.

There'll be no gas shortage as long as we pay the world price.

When it comes to the politicians' enthusiasm for constructing Adani's Carmichael coal mine in the Galilee Basin of central Queensland, however, they leave us with the impression its addition to world coal supply would have no effect on the world coal price (or global carbon emissions, for that matter).

But we're one of the world's biggest exporters of coal. And Carmichael would be one of the world's biggest mines.

So it couldn't help but push down the world price, relative to what it would otherwise be, to the detriment of all our existing coal producers and their employees, and government royalty and company tax collections.

The Queensland government is so keen to see the mine proceed ASAP it's willing to subsidise a rail line to a coastal port by $1 billion. Can you imagine what that would do to its net royalty revenues?

It claims the rail line isn't a subsidy because it's a loan (believe that if you like) and because the line will open up the Galilee Basin to other mines.

Should they emerge, however, the downward pressure on coal prices and tax receipts would be even greater.

All this says Australia has not much to gain and a lot to lose by pressing on with the development of one more coal mine.

At a time when the whole world needs to make the transition from fossil fuel to renewable energy as soon as we reasonably can, pushing down coal prices slows the process down by increasing the relative price disadvantage of renewables.

There seems to be something about political office in Australia that interferes with our pollies' economic reasoning powers. I can't think what it might be.

Saturday, December 17, 2016

What's happening in the labour market

Oh, no! They say the Bureau of Statistics' jobs figures for November are good because they show employment growing by 39,000, with all those jobs full-time. But then they say the unemployment rate increased a click to 5.7 per cent. Huh?

It is possible to make sense of what's happening in the labour market, but only if you follow a few rules.

For a start, it's never possible to make sense of the monthly figures if you focus on the change from last month because they're subject to sampling and other errors and keep bouncing around.

You make it doubly hard if you defy the bureau's advice and focus on its "seasonally adjusted" estimates rather than its "trend" (smoothed) estimates.

Also, employment and unemployment aren't opposite sides of the same coin. There's a third possibility: neither employed nor unemployed, because you don't have a job and aren't looking for one. The statisticians call this "not [participating] in the labour force".

So it's perfectly possible for both employment and unemployment to increase at the same time - if, say, some people are leaving the unemployed because they've found a job, while others are adding to the unemployed by joining the labour force to look for work.

But let's stick to the trend figures and step back for a longer view, looking at the 12 months to November.

The figures show total employment grew by 87,000 and the rate of unemployment fell 0.3 percentage points to 5.6 per cent.

If you think that sounds good, sorry. Over the same period, the proportion of working-age people participating in the labour force, either by having a job or looking for one, fell by 0.6 percentage points to 64.5 per cent.

About 0.25 percentage points of that fall would have been caused by the ageing of the population, but the rest was probably caused by "discouraged jobseekers" ceasing to be classed as unemployed because they gave up looking for work.

The bureau points out that growth in total employment of 87,000 is an annual increase of only 0.7 per cent, which is less than half the average growth rate over the past 20 years of 1.8 per cent.

Then, when you delve into the employment story you find that while part-time employment grew by 138,000, full-time employment actually fell by 51,000.

It's not so surprising that the jobs market isn't doing as well as our reasonable rate of growth in gross domestic product would lead us to expect, because a lot of the output growth is coming from increased production of minerals and energy, which involves employing very few extra miners.

But why are those jobs we are creating more likely to be part-time? The Reserve Bank investigated this question in last month's quarterly statement on monetary policy.

It says much of the recent swing from the creation of full-time jobs to the creation of part-time jobs is explained by the economy's return to non-mining led growth since the end of the mining construction boom.

The Reserve divides the economy into three broad sectors. First, the goods-related sector: agriculture, mining, manufacturing, construction, utilities and distribution (transport, postal and warehousing, and wholesale and retail trade).

Second, the business services sector: finance and insurance, administration and support, media and telecommunications, professional scientific and technical, and rental, hiring and real estate.

Third, the household services sector: health and aged care, education, accommodation and food, and arts and recreation.

"Since 2013," the Reserve says, "employment growth has been strongest in the household services sector, where the share of part-time employment is relatively high at about 45 per cent."

Over this period, the share of part-time employment in the business services sector and the goods-related sector has also increased but, at about 25 per cent, it remains much lower than for the household services sector.

Employment growth has been weakest in the goods-related sector, partly reflecting the loss of jobs as mining construction projects come to an end and the ongoing decline in manufacturing employment.

So far we've said that, since 2013, some sectors of the economy have growth faster than others, with the sector that's grown fastest also being the one that's always had the biggest proportion of part-time jobs.

But there's also been a shift to part-time employment within each of the sectors. The Reserve says this fits with what businesses are telling it in its "liaison" interviews, that they've been hesitant to employ full-time workers until they see evidence that increased demand for their output is likely to be sustained.

Of course, the share of part-time employment in total employment has been increasing steadily since the mid-1960s. Then, it was 10 per cent; today it's about a third.

Being able to employ people for those times in the week when you need them - rather than having full-timers with little to do for much of the week - has allowed firms to increase the efficiency with which they use labour.

So there's been growing employer demand for part-time workers. At the same time, however, there's been growing willingness among employees to supply their labour on a part-time basis.

The obvious examples are full-time students, parents of very young children and, these days, older workers seeking semi-retirement.

This makes it wrong to think that part-time jobs are inferior to full-time jobs, that everyone with a part-time job really wants a full-time job (there aren't many for whom that's true) or that all part-time jobs are casual rather than permanent.

What is true, however, is that with the rise in part-time employment has gone a rise in under-employment - essentially, people with part-time jobs who'd prefer to be working more hours.

Since February 1990, under-employment's risen from 4 per cent to 8.5 per cent today, though it's been steady for the past two years.

On the downside of the resources boom, employment growth isn't as strong as we'd like it to be.

Wednesday, December 14, 2016

Experts agree emissions intensity scheme the way to go

If ever there was proof that modern-day politicians are more followers than leaders, Malcolm Turnbull must be it. Last week, under pressure from the Coalition's climate change-denying rump, he dropped the ball on global warming.
He inherited from Tony Abbott a commitment under the Paris agreement to reduce our carbon emissions by 28 per cent below 2005 levels by 2030, plus a plan for a review in 2017 to determine what policies were needed to achieve that target.
Everyone's agreed that the government's existing direct action approach, taking money from the budget to pay farmers and others to cut their carbon emissions, is quite inadequate to achieve the new target.
The authorities responsible for advising the government on energy and climate change – the Climate Change Authority, the Chief Scientist, the Australian Energy Market Commission – have each decided the best approach would be to introduce an "emissions intensity scheme" on the electricity generation industry.
But last week, when Energy Minister Josh Frydenberg mentioned that the review would include examining an intensity scheme, the Coalition's deniers went ape and Turnbull summarily excluded such schemes from the review, claiming they would add too much to electricity costs.
We're not all climate change deniers, however – and far from all Coalition voters – so if we think something decisive should be done, the way forward is to convince Turnbull this is what most of his potential followers want.
In other words, it's our community and our economy and prime ministers don't get to dismiss options without us even being allowed to think about them and decide what we prefer.
Since electricity generation accounts for about a third of our total carbon emissions, it's pretty clear it will be the main focus of our efforts to reduce emissions, especially because of the emergence of renewable energy from wind and solar.
The final report of the energy market commission, released at the Council of Australian Governments meeting on Friday, evaluated three different policies for achieving the pledged reduction in emissions.
The first was one that would appeal to many environmentalists: extending the existing large-scale renewable energy target.
At present, the target is to achieve 33,000 gigawatt hours of renewable energy a year by 2020. To achieve our commitment under the Paris agreement, we'd have to more than double the target to 86,000 gigawatt hours a year by 2030.
The second approach was for a government regulator to work out which coal-fired power stations should be required to close down at which times, as renewable energy expanded.
You'd start with the oldest generators, including the particularly polluting brown coal generators.
The third approach was the one Turnbull rejected sight unseen: imposing an emissions intensity scheme on electricity generators.
You start by measuring the industry's present emissions intensity by dividing its total emissions of carbon dioxide in a year by its total production of electricity in the year.
This average becomes the industry's emissions intensity standard. Those generators operating above the standard have to get down to it by buying "credits" from those that are below it.
The standard is lowered – made more demanding – each year by the set amount needed to achieve the desired reduction in emissions.
See how it would work? The "dirtiest" generators – the coal-fired generators – also happen to be the ones whose electricity is cheapest to produce, whereas the cleanest producers – wind and solar – are the ones whose electricity is dearest.
So the cheap dirty generators are required to subsidise the expensive clean producers, thus creating a price incentive for the clean producers to expand and the dirty producers to contract.
It also means the overall price doesn't change much.
So how do the three approaches compare, according to the modelling done for the report – remembering that all modelling is built on a host of assumptions?
The extended renewable energy target turns out to be the worst approach. It leads to almost the biggest increase in the cost of electricity to consumers over the years to 2030.
It also has the highest cost per tonne of emissions reduced – $42 a throw.
This is because it doesn't allow businesses to pick the type of technology most appropriate to their needs. Dirtier brown coal would remain in the market for longer, while black coal and gas-fired generation were forced out.
Regulated closure of generators would cause the highest increase in prices to consumers, though its cost of emissions reduction is the second lowest - $19.50 a tonne.
The bureaucrats and politicians making decisions about which generators to close would have to get it right, avoiding the temptation to take account of political pressures and the interests of generous donors to party funds.
This leaves the emissions intensity scheme. It has the lowest effect on consumer prices relative to what the model assumes would happen to prices even if no attempt were made to reduce emissions.
It assumes consumer prices would still go up under "business as usual", but would rise by less under the intensity scheme.
It also has the lowest cost of reducing emissions – $17.50 a tonne.
So the option the formerly studious Turnbull rejected without considering is the best, and the one least likely to put prices up.
Well done, Malcolm. Especially as it's a safe bet Labor will be offering such a scheme at the next election.

Monday, December 12, 2016

Politicised Treasury bites own tail, covers for Turnbull

Shadow treasurer Chris Bowen is right: One of the Abbott-Turnbull government's various acts of economic vandalism is its politicisation of the once-proud federal Treasury.

Among Tony Abbott's first acts upon becoming prime minister in 2013 was to sack the secretary to Treasury, Dr Martin Parkinson.

Even so, Parkinson was left in place for more than a year before being replaced by John Fraser, a retired funds manager, hand-picked by Abbott.

Fraser had risen through the ranks of Treasury under the formative influence of the legendary John Stone, until he left in the early 1990s to make his fortune in the money market.

When Fraser returned in triumph to take the top job, singing the praises of Margaret Thatcher, Ronald Reagan and David Cameron's austerity policy in Britain, it seemed clear he hadn't spent the intervening decades keeping up with developments in thinking about fiscal (budgetary) policy.

The Abbott government's next act of politicisation came a few months later with the publication of Treasury's fourth five-yearly intergenerational report.

It had been turned into a partisan propaganda rag, full of dubious figuring intended to prove the Abbott government's failure to return the budget to surplus as promised was all the fault of the previous Labor government. The media tossed the report aside.

The latest stage in the politicisation of Treasury came last week with its publication of a report on The Effectiveness of Federal Fiscal Policy, commissioned from Professor Tony Makin, of Griffith University.

If you've never heard of Makin's work, you'll be surprised to learn he regards fiscal policy as utterly ineffective and probably counterproductive.

If you have heard of it, you won't be. Makin's views on the ineffectiveness of fiscal "activism" – using budgetary stimulus to assist recovery during recessions – are well known, unchanged and unchanging.

He's the go-to guy for anyone who'd like an independent report asserting that fiscal policy doesn't work – never has and never could.

In all the decades since Makin made up his mind on this question, all the academic theorising and empirical evidence from the real world have served only to confirm the wisdom of that decision.

His paper's "review" starts by rubbishing that deluded fool John Maynard Keynes – who, presumably, will never attain the intellectual heights reached by Makin and his mates – and praising such giants of the profession as Robert Mundell, Marcus Fleming, Robert Lucas and Thomas Sargent.

It then reprises Makin's well-rehearsed argument that the Rudd government's budgetary stimulus – undertaken at the urging of the then Treasury secretary, Dr Ken Henry – was unnecessary and unhelpful.

And finally it does a lot of hand-wringing about the rapid growth in the public debt (especially when you exaggerate the size of the debt by quoting gross rather than net, a trick Makin seems to have learnt from Barnaby Joyce), the burden being left to our children, and the need to make reducing recurrent government spending our top fiscal priority.

One small problem – the last time Makin ran his anti-activism line, in a paper commissioned by the Minerals Council, Treasury issued a detailed refutation. Makin seems to have taken none of its substantive criticisms into account in his Treasury-commissioned version.

This is a measure of the extent to which politicisation has changed Treasury's tune.

Apart from correcting various factual errors, old Treasury noted that the 1960s-era Mundell-Fleming open economy model Makin uses relies on extreme assumptions that don't hold in Australia's case, and certainly didn't hold during the global financial crisis.

Makin is unimpressed that, at that time, such lightweights as the International Monetary Fund and the Organisation for Economic Co-operation and Development heaped praise on the Rudd government's budgetary stimulus.

So why has new Treasury chosen now to pay one of its former critics to repeat his ill-founded criticisms?

One reason is that Fraser left Treasury not long after it had advised the Hawke government not to use fiscal policy to respond to the severe recession of the early 1990s, but to rely solely on monetary policy (lower interest rates).

Henry and others in Treasury eventually realised how bad that advice had been. Indeed, Henry's advice to Rudd was influenced by a determination not to repeat the mistake. But Fraser had left the building by then and didn't read the memo.

Another reason is that, now, both the IMF and the OECD are urging the Turnbull government to help strengthen the economy by increasing its spending on worthwhile infrastructure.

What's more, some guy called Dr Philip Lowe has been saying the same thing. Forcefully.

Makin has been hired to tell these idiots they don't know what they're talking about.

Saturday, December 10, 2016

How to tell if recession looms

What would economic race-calling be without its little excitements? As you may possibly have heard, this week's news is that the economy has contracted - shrunk, gone backwards - by 0.5 per cent.

Oh, no! Another negative quarter will see the economy lapse into "technical" recession. Technically true, but quite unlikely - as almost all the money market economists had the honesty to admit.

If you're more practical than technical, and you live in Sydney or Melbourne, the best way to judge whether recession looms is to look out the window.

Bearing in mind that anyone under 25 has never seen a severe recession, and that anyone under about 40 probably wasn't paying much attention in 1991, let me give you a hint: they don't look anything like what you see around you.

What the self-styled experts on "technical recessions" don't tell you - perhaps because they don't know - is that employment is falling and unemployment climbing rapidly during actual recessions and even before the "technical recession" is proclaimed by a slavering media.

Think about it: rapidly climbing unemployment is the main reason those of us who've lived through a few recessions don't toss the word around lightly.

So what do we know about the employment story in Sydney and Melbourne?

According to the Bureau of Statistics monthly survey of the labour force, over the year to October total employment in NSW rose by 39,000, while the rate of unemployment fell by 0.6 percentage points to 4.9 per cent (although this was fully offset by a fall in the rate of participation in the labour force).

Not all that wonderful, but a long way from the precursor to a recession.

As for Victoria, it's performance is pretty good: total employment up by 109,000 over the year to October, with the unemployment rate down 0.3 percentage points to 5.7 per cent, even while the participation rate rose by 0.9 percentage points.

If you live in Perth, however, looking out your window would convince you the West Australian economy is in something like a recession.

Over just the six months to October, employment has fallen by 19,000 (1.4 per cent) while the unemployment rate rose 0.7 points to 6.4 per cent and the participation rate fell by 0.9 points.

Get it? If we were in or near recession, you wouldn't need the technical brigade to tell you.

The other point is that most of the weakness in the nationwide figures comes from the very tough times in the 15 per cent of the national economy represented by WA - which, of course, is bearing the brunt of the massive fall-off in mining and natural gas construction activity.

NSW and Victoria aren't doing too badly.

But why the sudden sharp contraction in the national figures? The bureau's national accounts for the September quarter show that the 0.5 per cent contraction lowered the economy's annual rate of growth to 1.8 per cent, down from 3.1 per cent over the year to June.

Michael Blythe, chief economist for the Commonwealth Bank, offers the most enlightening metaphor, saying the economy had just hit a pothole.

Paul Bloxham, his opposite number at the HSBC Bank, says the fall reflected an (unusual) accumulation of various one-off factors.

"First, export growth was weak, as coal production was disrupted by a roof collapse at a key mine, and various other factors," he says.

"Second, residential construction fell in the quarter, which the statistics bureau noted was due to inclement weather.

"Third, there was a sharp fall in public investment spending, which followed a sharp rise in the June quarter.

"Finally, mining investment continued to fall as projects are being completed."

It's clear the first three of these are just temporary setbacks. "Export growth is expected to bounce back strongly in coming quarters, given that there is substantial capacity still to come on line in the resources sector, particularly liquid natural gas export facilities," Bloxham says.

Exports of services rose in the September quarter and are expected to continue to rise, supported by demand from Asia.

In home building, there's a substantial pipeline of work yet to be done on new apartment projects, which should keep housing construction growing in coming quarters, although this will come to an end after that.

The sharp fall in public investment is unlikely to be repeated next quarter. Capital spending by the public sector is, to be technical, "lumpy" - it jumps around from quarter to quarter. In this case the figures were distorted by the privatisation of a big asset.

This is the 12th quarter in a row that business investment spending has fallen because of the end of the mining construction boom.

Since December quarter 2012, mining investment's share of gross domestic product has fallen from its peak of 9.4 per cent to 3.4 per cent.

This says we can't be far from the bottom, which is good news. Bloxham says mining investment should level out - and thus stop making negative contributions to growth - around the middle of next year.

Anything's possible, but a second negative quarter seems unlikely.

Even so, when you look behind all the one-offs, you do see signs in these accounts that the economy may not be growing quite as strongly as we formerly thought.

Growth in consumer spending has been on the weak side for two quarters in a row, even though the bureau's latest stab at the household saving ratio (as a proportion of household disposable income) says it's down to 6.3 per cent, quite a bit lower than we thought. Low growth in wage rates is taking its toll.

In November, the Reserve Bank's forecast showed the economy continuing to grow by about 3 per cent next year, strengthening to about 3.5 per cent by the end of 2018.

My guess is, when we see the revised forecast in February, it will be down a bit on that, though not by a lot.

Wednesday, December 7, 2016

Why I'm a pathological optimist, in spite of my job

Last week in front of 1400 people at a Fairfax Media subscriber event I was outed as a "pathological optimist" by an anonymous reader, who wanted to know how I got that way.

It reminded me of Dylan Thomas, who went into a pub in America and got beaten up by some big bruiser – a future Trump voter, no doubt – for calling him heterosexual.

But, since you ask, I'll tell you – much as I hate talking about myself.

I think it's partly heredity, and partly by choice. When you grow up in the Salvos, professing to be "saved", it's natural to be happy with life and confident Someone Upstairs will look after you.

My mother was an incessant worrier and I grew up seeing her worrying about a lot problems that never eventuated. My father wasn't a worrier. I decided to take after my dad.

In truth, as optimists go I'm out and proud.

I can only guess at what the future holds, but people are always asking for my prediction.

If you want a forecast that errs on the optimistic side, I'm your man. If you want death and destruction, feel free to take your business elsewhere.

Many people switch between economic optimism and pessimism depending on whether they approve of the present government. Not me.

Of course, if I thought we were staring recession in the face I'd say so. Even if I thought the possibility was a lot higher than normal I'd say so – though I'd keep the announcement sober rather than sensational.

Most of the time, however, the safest and most likely prediction is that next year will be much the same as this year. When it's a half full/half empty choice, you know which way I'll jump. (You know, too, that an economist is someone who thinks the glass is twice as big as it needs to be.)

What I said at that event last week was that I'm an optimist because "it's easier to get through life that way".

It's true. I commend it to you. And I have scientific proof. Professor Martin Seligman, of the University of Pennsylvania, a founder of the positive psychology school and author of Learned Optimism, has written that optimism and hope are quite well-understood, having been the object of thousands of empirical studies.

They "cause better resistance to depression when bad events strike, better performance at work, particularly in challenging jobs, and better physical health".

Other research has shown that individuals who profess pessimistic explanations for life events have poorer physical health, are prone to depression, have a less adequately functioning immune system and are more frequent users of medical and mental healthcare.

A study by Toshihiko Maruta and others at the Mayo Clinic, which followed almost 450 patients over 30 years, found that optimists lived longer than pessimists and reported better physical and mental health. Wellness is attitudinal, not just physical.

My conclusion is that optimists live happier lives than pessimists. But are optimists happier people or are happy people more optimistic? Bit of both, is my guess.

Which is not to say optimism is rational or realistic. It isn't. Seligman defines optimism as a style of explaining life events.

Pessimists think the bad things that happen to them are permanent ("the boss is a bastard") whereas optimists think they're temporary ("the boss is in a bad mood").

Pessimists think the good things that happen to them are temporary ("my lucky day") whereas optimists think they're permanent ("I'm always lucky").

Pessimists have universal explanations for their failures ("I'm repulsive") whereas optimists have specific explanations ("I'm repulsive to him").

But don't knock self-deluding optimism. It's a motivating force for innovation and entrepreneurial endeavour and it keeps the capitalist system turning.

Business people invent new gismos and launch new products because they're convinced the new thing will be hugely successful, making their name and fortune.

Few succeed. Most do their dough. But the ones who do succeed make us more prosperous than we were. Then they try again.

But I confess my optimism is part professional calculation. As a commentator I have a contrarian streak. When all my competitors are saying black, I look for a way to say white.

This isn't hard or contrived because the media have an inbuilt tendency to predict the worse, believing this will please the audience and make them more popular.

Journalists believe our audience finds bad news more interesting than good news. For sound evolutionary reasons I've discussed before, this is right.

But ever intensifying competition has prompted the media to go over the top in their search for the big and bad.

Trouble is, most readers are optimists like me. They want to sustain their belief that, despite the bad things happening, the world is still fundamentally good, Australians are basically decent people despite some recent lapses, and life will get better, not worse.

I fear the bad-worse-worst news formula may be too depressing for some people, prompting them to switch to Facebook and photos of their friends' latest holiday.

If that's how you feel, dear reader, I'm here to help.

Monday, December 5, 2016

Education efficiency should start with Grattan compromise

If Treasury wants to start acting more like economists than accountants, a good place to start would be to urge its political masters to seize on the opportunity presented by the school funding "compact" proposed by the Grattan Institute.

Treasury advice would be much improved if it switched its approach to the budget from helping the politicians cook up some quick cuts to government spending to a more medium-term focus on achieving better value for the taxpayers' dollar through greater efficiency and effectiveness.

A more medium-term approach allows greater scope for micro-economic considerations to be incorporated into decision making.

The policy quagmire of school education is crying out for Treasury's guiding hand. It's hard to believe that school funding is still dogged by century-old sectarian rivalry between the public, Catholic systemic and independent school systems.

Thanks to this unending rivalry, the nation spends almost all its time arguing over how public funding is shared between the three systems, leaving little time to debate how well the money's being spent and how it could be better spent.

Meanwhile, domestic performance measures (NAPLAN) show, at best, no improvement in our performance over time, and international measures (PISA) show other countries improving while we mark time.

Our results show a wide gap between our best and worst performing students, which hasn't changed much, neither because our best have got better nor because our worst have got less worse.

Is this something Treasury is happy to see roll on? One unlikely to have much adverse effect on either the budget balance or national productivity?

Well, if we keep putting most of our energy into public versus Catholic versus independent, rest assured it will.

The Gonski funding review came up with a breakthrough proposal to rise above sectarian squabbling by moving to the division of combined federal and state funding on the basis of student need, regardless of which silo a disadvantaged student was in.

The Gillard government belatedly introduced a bastardised and far more expensive version of "Gonski", which the Abbott government pretended to support but disavowed immediately on winning office.

So the sectarian standoff remains. The Coalition isn't prepared to implement Labor's version of Gonski because it's too expensive, but it's too expensive because of Labor's promise to help the poor schools (those with many disadvantaged students) at no cost to the rich schools (those with few disadvantaged students).

Trouble is, until we direct more funds to the disadvantaged students, we don't stand much hope of improving our schooling outcomes.

Of course, a more efficient allocation of funds is just the first step towards improving the outcomes of disadvantaged students –  which is why it's so important to move the debate on from how the money's divided to how effectively it's being spent.

Clearly, moving to needs-based funding is as much about efficiency as about equity (fairness).

It makes zero economic sense to continue overfunding some students while those you underfund become an underclass of poorly educated workers who spend a lifetime in and out of employment, making a weak contribution to national productivity (not to mention being a recurring drag on the budget).

The 2014 budget did nothing to correct the maldistribution of federal funding to public and private schools, it just cut the basis of annual indexation from a high rate set by the Gillard legislation to just the consumer price index (much less than the rise in teachers' wages). It was about cost shifting, not reform.

This was always unsustainable politically. In the end, Malcolm Turnbull relented and promised to keep the original funding arrangement going for another three years to 2020.

Turns out grants are set to grow by 3.6 per cent a year, whereas teachers' salaries are more likely to grow by 2.5 per cent.

The genius of the "circuit-breaking new compact" proposed by Peter Goss and Julie Sonnemann of the Grattan Institute is that it seizes this rare chance to propose a deal that would get all schools up to 95 per cent of needs-based funding (the "schooling resources standard") by 2023, much earlier even than Gillard's plan.

This would involve schools below the 95 per cent benchmark having their funds raised by 3.6 per cent a year, while those between 95 and 100 per cent of the standard would rise by 2.5 per cent and those already above the standard would mark time.

This last element is the compact's point of political vulnerability, of course, and already Labor has found it.

Put the Labor opposition's personal ambitions ahead of the interests of disadvantaged students? Why not, says Labor's spokeswoman, the not so lovely Tanya Plibersek.

Let's hope Treasury has higher principles than Labor.

Saturday, December 3, 2016

Many guesses why productivity may have stopped improving

Conventional economics is falling apart, no longer making the sense we thought it made. Economists are entering a period of puzzlement and uncertainty, while their high priests struggle to hold the show together.

You can tell all that if you read between the lines of the Productivity Commission's discussion paper launching its inquiry into Increasing Australia's future prosperity, published last month.

It’s meant to be the first five-yearly review of our productivity performance, the micro-economic equivalent of Treasury’s (misnamed and now politically hijacked) five-yearly macro-economic intergenerational reports.

So it has potential to be a big deal. If you missed hearing about the discussion paper it may be because it was overshadowed that week by something that happened to a Mr Trump.

The commission opens its discussion with the alarming observation that "there is a justified global anxiety that growth in productivity – and the growth in national income that is inextricably linked to it over the longer term – has slowed or stopped".

Productivity is a measure of an economy's (or a business's) ability to convert inputs of resources into outputs of goods and services.

We commonly (and least inaccurately) measure it as output per unit of labour input – per worker or per hour worked.

But the commission prefers to measure it as output per unit of both labour and capital inputs, which it calls "multi-factor productivity". This is intended to be a measure of the essence of productivity improvement: technological advance and increased human capital.

Trouble is, the commission says, "since 2004, multi-factor productivity has stalled, here and around the developed world. This is a long enough period to suggest something is seriously awry in the economic fundamentals and the consequent generation of national wealth and individual opportunity."

Actually, by the commission's own figuring, Australia's labour productivity in the "12-industry market economy" improved by 1.9 per cent in 2014-15, the most recent year available, and our multi-factor productivity improved by 0.8 per cent, which was also our average rate of multi-factor improvement over the previous 40 years.

It's true, however, that our multi-factor performance has looked pretty sick since the turn of the century.

But the first point to note is that the problem is global, not just some weakness of ours – a fact a lot of those who've used our weak numbers to push their own favoured "reforms" have often failed to mention.

Next point, which is also often not mentioned: economists can't measure multi-factor productivity with even remote accuracy. That's mainly because they can only guess at the contribution one unit of physical capital (whatever that is) makes to production.

So it's hard to be sure the weak multi-factor productivity figures most developed countries are producing are real.

Next, assuming they are real, economists can only guess at the factors causing them. There's a lot of guessing going on by some of the world's top economists, but as yet there are no policy changes we could make with any confidence that they'd fix the problem.

Our eponymous commission produces an annual update on our productivity figures but, though it's been wringing its hands for years, its analysis has never once been able to put its finger on a causal factor we could do something about.

The few explanations it's found are either temporary or nothing to worry about.

The discussion paper acknowledges, but then dismisses, the argument of those wondering if the whole "problem" is merely a product of monumental mismeasurement.

I don't dismiss it. Had the economists not assured us of the opposite, most of us would look at the wonders of the digital revolution and the many industries being hit by digital disruption and assume the productivity indicators must be going gangbusters.

How can we be sure they aren't? One of our most thoughtful economists – one who's always gloried in digital advances – is professor John Quiggin, of the University of Queensland.

Quiggin argues that the economists' conventional model for thinking about the economy and how it grows is based on an industrial economy, which made sense in the 19th and 20th centuries, but is becoming increasingly outmoded and misleading.

We focus hard on the production of goods – agriculture, mining and manufacturing – but are vaguer about the production of services, which is the main part of the economy that's growing.

Today, he says, the primary engine of economic development is information, but information has radically different characteristics to a physical good or a service such as a haircut.

Information is often free ("non-excludable", as economists say) and it can't be used up ("non-rivalrous").

This outdated, industrial-age way of thinking about growth and productivity is reflected in the way we define and measure the economy and productivity via gross domestic product.

For instance, we measure only economic activity in markets, meaning we exclude all the activity taking place in households, and can't measure the productivity of the 20 per cent of GDP created in the public sector, including such minor industries as health and education.

And we ignore one of the most valuable outcomes of the greater prosperity that is the Productivity Commission's god: hours of leisure.

None of this, however, will stop the commission using its ultimate report to advocate a bunch of "reforms" intended to improve our small corner of the world's alleged productivity problem.

As we speak, Canberra's second biggest industry – the lobbyists – are busy churning out their self-interested submissions to the inquiry, advocating such radical new ideas as cutting company tax and weekend penalty rates.

To be fair, the commission says it's "particularly interested in new and novel ideas because there is already a strong awareness of many reform options that parties would like to see implemented. More of the same is not likely to be helpful."

We'll see how far it gets with that fond hope.

Friday, December 2, 2016


Talk to Economics Teachers Association of WA, Perth, Friday, December 2, 2016

The theme for your conference, Economic Cycles - Riding the Waves, is particularly well chosen. At a time when Western Australia is well and truly in the downswing of its cycle, the national economy is celebrating have completed 25 years of continuous growth, a record for our economy and something no other developed economy has achieved in the same period. I’ll leave it to Nicky Cusworth to look closely at the ups and downs of the WA economy, but how can we say the national economy is sailing along while WA is making such heavy weather of it? Because, as the RBA’s chief economist, Dr Chris Kent, reminded us last week in a speech that’s well worth West Australians looking up,

the national economy is just the weighted average of the six state and two territory economies. And whereas a few years back the mining states, WA and Queensland, were riding high and NSW and Victoria were doing it tough, the end of the boom has seen those roles reversed.

Why we’ve gone 25 years without a severe recession

I’ll say no more about that, but switch the focus back to the national economy and the question of how we’ve been able to keep the economy growing for so long. A lot of people think the answer is obvious: China has kept us going. But that’s wrong. For one thing, the resources boom didn’t start till about 2003, roughly half way through the 25 year period. More fundamentally, giving all the credit to China reveals an ignorance of the way economies move in cycles. You can say that China’s resources boom added greatly to the amount of economic growth over the period, but it’s a strange argument to say that introducing a huge boom and bust - first, in coal and iron ore prices and then in mining and natural gas construction activity - explains why the economy has never contracted in 25 years, even though, before that - and still in other developed economies - recessions are usually about seven years apart. To put it another way, economies rarely drop into recession just because they’ve run out of puff. They usually do it because someone jammed on the brakes too hard. And they usually jam on the brakes because they’re reacting to a boom they’ve let run away and become too inflationary.

As the RBA governor, Dr Phil Lowe, remarked in one of his recent speeches, our 25-year expansion is the more remarkable when you remember the major “economic shocks” that hit our economy during the period and could have knocked us off track the way they did many other countries: the Asian financial crisis of 1997-98, the US Tech Wreck of 2001 and the global financial crisis of 2008.

So why didn’t they? More because of our good management than our good luck. The microeconomic reforms of the 1980s and 1990s made the economy more flexible - better able to roll with the punches from economic shocks - and thus less inflation-prone and unemployment-prone. The reduction of protection and the floating of the dollar made our industries more open to competition from imports, while deregulation heightened competition between domestic players. Increased competition - including in the provision of utilities - also reduced cost-push inflation pressure by reducing the pricing power of some industries and their unions. The move from centralised wage-fixing to collective bargaining at the enterprise level reduced the risk of excessive wage increases and, as we saw in the wake of the GFC, reduced the tendency of employers to respond to downturns with mass layoffs.

A more flexible, less-inflation prone economy is one that’s easier for the macro managers to keep stable. But we’ve see reforms also at the macro-economic level with the establishment of formal “frameworks” for the way fiscal policy and, more notably, monetary policy should be conducted. Monetary policy decisions are now made by the RBA independent of the elected government, and in accordance with the medium-term inflation target.

You can see how the macro stabilisation task benefits both from the greater flexibility arising from micro reforms and from the more deft use of the macro policy arms arising from the introduction of “frameworks” in the way we handled the biggest economic shock to hit our economy since the Gold Rush, the resources boom. Previous commodity price booms to hit our economy have led to inflation surges, followed by belated corrective action, followed by busts and recessions. Knowing this, the econocrats went to great lengths to ensure it didn’t happen this time. In this they were greatly assisted by the move to a floating exchange rate. Rather than having to wait too long while the government accepted the need for revaluation, the floating rate appreciated immediately and significantly in response to the increase in export prices. One effect of this was to shift some of the benefit of the improvement in our terms of trade away from the mining companies to all those businesses and consumers who bought imports. But another effect of the high dollar was to reduce the demand for tradable goods and services - such as manufactures, tourism and international education - thus making it easier for resources to shift from the contracting sectors to the expanding mining sector without great inflation pressure. Decentralised wage fixing, plus the use of temporary 457 visas, kept the rise in mining sector wages from spreading to wages everywhere. The result of all this was that the resources boom’s potential inflation pressure was contained, but at the expense of weaker growth in the non-mining states.

By now, as you well know, the price and construction phases of the resources boom have come to an end and, although the increased-production phase has further to run, the economy has been making a transition from mining-led growth to growth led by other parts of the economy. Growth in the non-mining economy is being stimulated by a very expansionary stance of monetary policy and by a large fall in the dollar (in belated response to the fall in export prices and deterioration in the terms of trade), although we’re not getting much help from slowing growth in China, moderate growth in the United States and weak growth in Japan and Europe.

Recent record and outlook for the economy

We’ll get another reading from the national accounts next week, but previous quarters show real GDP growing at the rate of 3 per cent - which, as we’ll see, is just a fraction faster than our “potential” growth rate. The RBA’s most recent forecasts show the economy continuing to grow at about 3 per cent next year, strengthening to about 3.5 per cent by the end of 2018. This would involve inflation gradually returning to the 2 to 3 per cent target range. The unemployment rate should improve only marginally, with the labour market weaker than it seems from looking just at the level of the official unemployment rate.

If you find that hard to believe, the explanation is simple: most of the growth is coming from NSW and Victoria (which account for 55 per cent of the national economy), with most of the weakness coming from WA (accounting for less than 15 per cent) and mixed performances in Queensland, SA and Tasmania. The NSW economy is growing so strongly it even has strong growth in non-mining business investment; which is going backwards in WA. The RBA estimates we are about 80 per cent of the way through the decline in mining investment as the pipeline empties out.

Australia’s lower potential growth rate

Australia’s present and prospective rate of economic growth is lower than we experienced in earlier years. This is partly for cyclical reasons - the continuing transition from the resources boom, especially in WA - but also for longer-lasting structural reasons. You can see this in the way the econocrats have been revising down their estimate of our “potential” growth rate. Our potential growth rate is determined by the supply-side of the economy, rather than the demand side. It is the average rate of growth in the economy’s capacity to produce goods and services over the medium term. It can be raised by growth in the labour force, growth in investment in business equipment and infrastructure and improvement in productivity. Once the economy is operating at full capacity utilisation - full employment - our potential growth rate sets the speed limit at which the economy can grow without excessive inflation. But while the economy is operating with spare production capacity - that is, while it has a negative “output gap” - it can grow at rates exceeding the potential rate without worsening inflation.

An economy’s output gap is a measure of the extent of its spare production capacity. Where its actual rate of growth is lower than its potential growth rate, the difference contributes to a negative output gap. Where the actual rate of growth is higher than the potential rate of growth, and economy is at full employment, the difference is a positive output gap, which will be causing inflation pressure to build. Note that, because the economy’s ability to produce goods and services gets a bit bigger almost every year, potential is a rate of growth.  By contrast, the output gap is a level, an absolute amount - the deference between one level of GDP and another level.

It’s hard to calculate an economy’s potential growth rate (or, for that matter, its NAIRU - non-accelerating-inflation rate of unemployment) with any degree of certainty. And the rate will change over time as the factors affecting it change. For a long time Australia’s potential rate - often referred to as our (forward-looking) “trend” rate of growth - was taken to be 3.25 per cent a year. But then this was lowered to 3 per cent and last year it was cut further to 2.75 per cent. Why? Because of slower population growth since the end of the resources investment boom, because the retirement of the baby boomers is lowering the labour force participation rate (only partly offset by the trend to later retirement) and because, as is true for all the developed economies, Australia’s rate of productivity growth is lower than it used to be.

It’s roughly estimated that, because of many years of weak growth until the past year or so, our negative output gap is equivalent to about 1.5 per cent of GDP. That is, actual growth could be a cumulative 1.5 percentage points higher than the potential rate before we reached full capacity and had to slow down to the potential rate to avoid excessive inflation. But each year that we grow by more than 2.75 per cent will take up spare capacity and reduce the output gap.

Now let’s turn to recent developments in the management of the macro economy using monetary policy and fiscal policy, starting with monetary.

Monetary policy

Monetary policy - the manipulation of interest rates to influence the strength of demand - is conducted by the RBA independent of the elected government. It is the primary instrument by which the managers of the economy pursue internal balance - low inflation and low unemployment. MP is conducted in accordance with the inflation target: to hold the inflation rate between 2 and 3 pc, on average, over the medium term. The primary instrument of MP is the overnight cash rate, which the RBA controls via market operations.

The RBA cut the official interest rate hard in response to the GFC in 2008, but then put rates back up once it became clear a serious recession had been averted.

In November 2011, the Reserve decided the resources boom was easing and would not push up inflation. It realised growth in the non-mining sector of the economy was weak - held down particularly by the dollar’s failure to fall back in line with the fall in export prices – at a time when mining-driven growth was about to weaken. So it began cutting the cash rate, getting it down to a historic low of 2.5 per cent by August 2013.

For the next 18 months the Reserve sat back and waited for this very low interest rate work through the economy and have its effect. Not all that much happened, with the economy continuing to grow at a below-trend rate. The dollar did start falling in the first half of 2013, and by June 2015 it had dropped to about US77 cents (from its peak of US1.10 in mid-2011), but this would have been explained much more by the continuing fall in coal and iron ore export prices than by our lower interest rates relative those in the major advanced economies. The Reserve continued to note that the exchange rate hadn’t fallen by as much as the fall in commodity prices implied it should have, explaining this as a consequence of the major advanced economies’ resort to “quantitative easing” (money creation), whose main stimulatory effect on their economies came by forcing their exchange rates lower (thus causing ours to be higher than otherwise).

So in February 2015, after a gap of 18 months, the Reserve resumed cutting rates, dropping the official rate another notch, and again in May, to reach a new low of just 2 pc. It resumed cutting a year later, in May 2016, and then by another notch in August, taking the cash rate to a new record low of 1.5 per cent. There is little reason to doubt that the total fall of 3.75 percentage points since November 2011 has helped to hasten growth the non-mining sector of the economy. In particular, it prompted the boom in the housing market, causing big increases in house prices and new home building, particularly in Sydney and Melbourne. How much the lower rates contributed to the fall in the exchange rate is debatable.

The further rate cuts in 2016 were made possible by the weakness in inflation and wages growth, with the inflation rate falling short of the target range. It’s doubtful whether the Reserve expects the recent cuts to do much to encourage borrowing and spending. More likely it is hoping that lowering our rates - which are still high relative to rates in the major economies - will exert some downward pressure on our exchange rate, thus improving the international price competitiveness of our export and import-competing industries. In his final speech, retiring Reserve governor Glenn Stevens acknowledged that the effectiveness of monetary has been reduced by the already-high debt level of Australian households, which has limited their willingness to borrow more so as to spend more - the main mechanism by which lower interests stimulate demand. Mr Stevens noted that Australia’s households are far more heavily indebted than our government, arguing that, if further policy stimulus is needed, it should come from fiscal policy: increased public borrowing and spending, provided this spending is on useful infrastructure rather than recurrent expenses.

Fiscal policy

Fiscal policy - the manipulation of government spending and taxation in the budget - is conducted according to the Turnbull government’s medium-term fiscal strategy: “to achieve budget surpluses, on average, over the medium term”. This means the primary role of discretionary fiscal policy is to achieve “fiscal sustainability” - that is, to ensure we don’t build up an unsustainable level of public debt. However, the strategy leaves room for the budget’s automatic stabilisers to be unrestrained in assisting monetary policy in pursuing internal balance. It also leaves room for discretionary fiscal policy to be used to stimulate the economy and thus help monetary policy manage demand, in exceptional circumstances - such as the GFC - provided the stimulus measures are temporary.

The Abbott government’s first budget, in 2014, set out a program of largely delayed measures to return the budget to surplus over a number of years. The measures focused heavily on cutting spending programs of benefit to low and middle-income families, ignoring the many overly generous tax concessions on superannuation, negative gearing and capital gains tax, whose benefits go predominantly to high income-earners. Because many of the spending cuts were contrary to Mr Abbott’s election promises, and many were judged to be unfair, the budget caused a plunge in the Abbott government’s popularity, from which it never recovered. Many of its cuts were blocked in the Senate.

The Abbott government’s second budget, in 2015, made little further attempt to reduce the budget deficit and seemed to focus mainly on measures intended to restore the government’s standing in the opinion polls. The deficit in 2015-16 was twice the size of the deficit in 2012-13.

The Turnbull government’s first budget, in 2016, attempted to do no more than hold the line on the deficit while it introduced a package of tax reform measures. It propose a minor cut in income tax, but its centrepiece was a plan to cut the rate of company tax from 30 to 25 per cent, phased in over 10 years. To help cover the cost of this cut, the budget sought to increase taxes in three main ways: by big increases in the tax on tobacco, a very worthwhile reduction in superannuation tax concessions and a serious crackdown on tax avoidance by multinational companies. The government is likely to have more success in getting these tax increases through the Senate than its cuts in company tax for big business. If so, its budget may end up making a useful contribution to reducing the budget deficit.