Saturday, December 16, 2017

Who's ripping it off? Competition theory and reality

Puzzling over the rich economies' poor productivity improvement and weak wage growth (but healthy profits), American economists are pointing the finger at reduced competition between firms. But can this explain Australia's similar story?

Jim Minifie, of the Grattan Institute, set out to answer this in his report, Competition in Australia.

Economists regard strong competition between businesses as essential to ensuring market economies function well, to the benefit of consumers and workers.

Competition is what economic theory says stops us being ripped off by the capitalists. Firms that overcharge for their products lose business to firms that undercut them.

So competition pushes prices down towards costs (which economists – but not accountants – define as including the "cost of capital", or "normal profit", the minimum rate of profit needed to induce firms to stay in the market).

Competition helps ensure that economic resources - land, labour and (physical) capital – move to the uses most valued by consumers.

Competition also encourages firms to come up with new or better products – or less costly ways of producing a product – in the hope of higher profits. But those that succeed in this soon find their competitors copying their ideas, and bidding down the price to get a bigger slice of the action.

The innovations improve the economy's productivity (output per unit of input), but competition soon takes away the higher profits, delivering them into the hands of consumers, who often get better products for lower prices.

That's the theory. Question is, to what extent does it hold in practice? And does it hold less in recent years than it used to?

The simple theory assumes any market has a large number of sellers, each too small to be able to influence the market price. In practice, however, many of our markets are dominated by two, three or four big firms.

Why? Mainly because of the presence of economies of scale. It's very common that the more you produce of something – up to a point – the less each unit costs.

So, it makes great sense to have a small number of big firms doing much of the production – provided competition ensures most of the cost saving is passed on to customers in lower prices. Which, as a general rule, it has been over the decades.

Trouble is, big firms do have some degree of control over prices. And it's common for the few big firms in an industry to come to an unspoken agreement to compete using advertising or product differentiation, but not price.

Firms can increase their pricing power by taking over their competitors to get a bigger share of the market. It's the role of "competition policy" – run in our case by the Australian Competition and Consumer Commission – to prevent overt collusion between firms, and takeovers intended to increase market power. But how well is that working?

"Natural monopolies" – where it simply wouldn't make economic sense for more than one firm to serve a particular market, such as rival sets of power lines running down a street, or two service stations in a small town - are another common departure from the theoretical model.

So, what did Minifie find in his study of competition in practice? He found evidence it had lessened in the United States, but not here.

He found plenty of markets where a few firms did most of the business. But "the market shares of large firms in concentrated sectors are not much higher in Australia than in other countries [of comparable size], and they have not grown much lately," he says.

Nor have their revenues (sales) grown faster than gross domestic product. The profitability of firms – profits relative to funds invested - hasn't risen much since 2000.

Minifie identifies eight industries characterised by natural monopoly (in descending order of size): electricity transmission and distribution, wired telecom, rail freight, airports, toll roads, water transport terminals, ports and pipelines.

Then there are nine industries where large economies of scale mean they're dominated by a few firms: supermarkets, wireless telecom, domestic airlines, then (of roughly equal size) internet service providers, pathology services, newspapers, petrol retailing, liquor retailing and diagnostic imaging.

Next are eight industries subject to heavy regulation by government: banks, residential aged care, general insurance, life insurance, taxis, pharmacies, health insurance and casinos.

(Often, these industries are heavily regulated for sound public policy reasons, but the regulation often acts as a barrier to new firms entering the market, thus allowing them to be dominated by a few firms.)

But note this: by Minifie's calculations, natural monopolies account for only about 3 per cent of "gross value added" (a variant of GDP), while high scale-economies industries account for 5 per cent and heavily regulated industries for 7 per cent.

So that means the parts of the economy where "barriers to entry" limit competitive pressure make up about 15 per cent of the economy. Then there are 29 industries with low barriers to entry making up the rest of the "non-tradables" private sector, and about half the whole economy.

That leaves the tradables sector (export and import-competing industries) accounting for 14 per cent of the economy and the public sector making up the last 20 per cent.

Even so, Minifie confirms that, in industries dominated by a few firms, many firms make "super-normal" profits – those in excess of what's needed to keep them in the industry.

By his estimates, up to half the total profits in the supermarket industry are super-normal. In banking it's about 17 per cent.

Other companies and sectors with substantial super profits include Telstra, some big-city airports, liquor retailers, internet service providers, sports betting agencies and private health insurers.

Comparing this last list with the lists of natural monopolies and heavily regulated industries suggests governments could be doing a much better job of ensuring the regulators haven't been captured by the companies being regulated.
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Wednesday, December 13, 2017

Robots won't reduce the amount of work we need to do

For me, one of the most significant economic developments of this year was realising how pessimistic many of our youth have become about their prospects of ever landing a decent full-time job.

To be sure, some degree of frustration on their part is understandable. Although it's true we avoided a severe recession following the global financial crisis of 2008, it's equally true that, until recently, employment growth has been weaker than usual in the years since then.

And the burden of this weaker growth has fallen disproportionately on young people leaving education to look for their first full-time job.

What's less understandable is the way older, and supposedly more knowledgeable, people have sought to demonstrate how with-it and future-focused they are by spreading wildly exaggerated predictions about how many jobs will be taken by robots, scaring the pants off our youth and convincing them they're doomed to a life of "precarious employment" in the "gig economy".

I'm sorry to say that the otherwise-worthy Committee for Economic Development of Australia was responsible for writing on many young minds the near certitude that 40 per cent of jobs in Australia are likely to be automated in the next 10 to 15 years.

The good news, however, is that, for once, economists were moved by all the amateur analysis they were hearing to join the debate about the future of work. Dr Alexandra Heath, of the Reserve Bank, dug out the hard evidence about how the nature of work is changing and Dr David Gruen, of the Department of Prime Minister and Cabinet, put worries about the shrinking number of jobs into their historical context.

But the charge has been led by Professor Jeff Borland, of the University of Melbourne, one of our top labour-market economists.

With a colleague, Dr Michael Coelli, Borland examined the papers behind the claim of 40 per cent of jobs being lost to robots, and found it built on questionable foundations. In their figuring, the 40 per cent was likely to be nearer 9 per cent.

And last week Gruen rejoined the fray, giving a big speech about it in, of all places, Jakarta.

Predictions about what will happen in the economy can be based on the belief that it will respond to new developments in much the same way it responded in the past to similar developments, or on the belief that "this time is different".

People who know little economic history are always tempted, as many people are now, to assume this time is different.

But economists have learnt the hard way that this time is rarely very different. The fact is, people have been predicting that the latest technology would reduce the number of jobs since the Luddites at the start of the Industrial Revolution.

Gruen reminds us that, in 1953, the great Russian-American economist Wassily Leontief wrote that "labour will become less and less important ... More and more workers will be replaced by machines."

Borland notes that, in the 1960s, Lyndon Johnson established a presidential commission to investigate fears that automation was permanently reducing the amount of work available.

In 1978, Monash University held a symposium on the implications of new technologies, with the convenor predicting that, by 1988, at least a quarter of the Australian workforce would be made redundant by technological change.

Then there was Labor legend Barry Jones' prediction in his best-selling Sleepers Wake! that "in the 1980s, new technologies can decimate labour force in the goods producing sectors of the economy".

Gruen admits that "there is no doubt that, over the past two centuries, waves of technological change have eliminated jobs, and rendered some occupations obsolete.

"But they have also facilitated the creation of new jobs to take their place – either directly, or indirectly as a result of rising standards of living generating new demands."

There are two processes at work, he says. One is that technology takes jobs away – this is the bit we can all see. What we can't see is the second process, the invention of new complex tasks, leading to new jobs.

The history of technological advance over the past 200 years has shown the second process has broadly kept pace with the first.

Computers have been changing the way businesses do their business – and destroying jobs – since the early 1980s. If that's all there was to it, there ought to be far fewer jobs today.

But the number of Australians with jobs has increased by a factor of 2.7 since the mid-1960s, while the average number of hours worked per person has remained broadly stable. Fact.

Like the economists, I find it hard to believe this relationship is about to break down because "this time is different".

What's true is that the nature of work has been changing – slowly – for the past 30 years or so, and this trend is likely to continue. It may accelerate, but it hasn't yet.

Using research by Heath, Gruen says routine cognitive jobs (such as office assistants, sales agents, brokers and drivers) and routine manual jobs (factory workers, construction, mechanics) are in less demand, whereas non-routine manual jobs (nurses, waiters, security staff) and non-routine cognitive jobs (engineers, management, healthcare, designers) are in increasing demand.

It's the changing nature of work, not a fall in the amount of it, we should be preparing for.
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Monday, December 11, 2017

We should rescue economics from the folly of neoliberalism

There's no swear word in politics today worse than "neoliberalism". It's badly on the nose, and the reaction against it has a long way to run. But what is it, exactly? Where does mainstream economics stop and neoliberalism begin?

The term means different things to different people. Professor Dani Rodrik, of Harvard, says in the Boston Review the term is used as a catchall for anything that smacks of deregulation, liberalisation, privatisation or fiscal (budgetary) austerity.

I've always thought of it as a fundamentalist, oversimplified, dogmatic version of conventional economics, one from an elementary textbook, not a third-year text that adds the complications of market power, externalities​ (costs or benefits not captured in market prices), economies of scale, incomplete and asymmetric (lop-sided) information, and irrational behaviour.

Rodrik's conception of the term isn't very different. He thinks mainstream economics needs to be rescued from neoliberalism because, as people heap scorn on it, we risk throwing out some of economics' useful ideas.

Which are? That the efficiency with which an economy's resources are allocated is a critical determinant of its performance. That efficiency, in turn, requires aligning the incentives of households and businesses with "social" costs and benefits (so as to internalise the externalities).


That the incentives faced by entrepreneurs, investors and producers are particularly important when it comes to economic growth. Growth needs a system of property rights and contract enforcement that will ensure those who invest can retain the returns on their investments.

And that the economy must be open to ideas and innovations from the rest of the world. Of course, economies also need the macro-economic stability produced by sound monetary policy (low inflation) and budgetary sustainability (manageable levels of public debt).

Does all that smack more of neoliberalism than mainstream economics to you? If it does it's because mainstream economics shades too easily into ideology, constraining the choices that we appear to have and providing cookie-cutter solutions.

"A proper understanding of the economics that lies behind neoliberalism would allow us to identify – and to reject – ideology when it masquerades as economic science. Most importantly, it would help us develop the institutional imagination we badly need to redesign capitalism for the 21st century."

There's nothing wrong with markets, private entrepreneurship, or incentives, Rodrik says, provided they're deployed appropriately. Their creative use lies behind the most significant economic achievements of our time.

The central conceit and fatal flaw of neoliberalism is "the belief that first-order economic principles map onto a unique set of policies, approximated by a Thatcher-Reagan-style agenda" – also known as the "Washington consensus".

Take intellectual property rights. They're good when they protect innovators from free-riders, but bad when they protect them from competition (as they often do when the US Congress has finished with 'em).

Consider China's phenomenal economic success. It's largely due to its orthodoxy-defying tinkering with economic institutions. "China turned to markets, but did not copy Western practices in property rights. Its reforms produced market-based incentives through a series of unusual institutional arrangements that were better adapted to local context," Rodrik says.

Some may say China's institutional innovations are purely transitional. Soon enough it will have to converge on Western-style institutions if it's to maintain its economic progress. Well, maybe, maybe not.

What neoliberal proponents of the single route to economic prosperity keep forgetting is that none of the economic miracles that preceded China's – in South Korea, Taiwan and Japan – followed the Western formula. And each did it differently.

Even among the rich countries we see much variance from the neoliberal cookie cutter. The size of the public sector, for instance, varies from a third of the economy in Korea, to nearly 60 per cent in Finland.

In Iceland, 86 per cent of workers are in a trade union; in Switzerland it's 16 per cent. In America firms can fire workers almost at will; in France they must jump through many hoops.

Rodrik repeats an old economists' saying, one forgotten by the neoliberal oversimplifiers. "Good economists know that the correct answer to any question in economics is: it depends."

It depends on the particular circumstances, on how well your economic "institutions" (laws, official bodies, norms of behaviour) fit with those the model assumes to exist, on what you're trying to achieve, on your priorities, and on the political constraints you face.

As the Chief Scientist, Dr Alan Finkel, said when asked if he preferred his own emissions intensity scheme to Malcolm Turnbull's national energy guarantee: "There are a lot of ways to skin a cat."

Economics has many useful insights to offer the community. It must be rescued from neoliberalism because neoliberalism is simply bad economics.
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Saturday, December 9, 2017

Mixed news as economy readies for better times

Scott Morrison is right. We're experiencing "solid" growth in the economy – provided you remember that word is econocrats' code for "not bad – but not great".

This week's national accounts from the Australian Bureau of Statistics show real gross domestic product grew by 0.6 per cent in the September quarter. Taking the figures literally, this meant the economy grew by 2.8 per cent over the year to September, way up on the 1.9 per cent by which it grew over the year to June.

But it's often a mistake to take the quarterly national accounts – the first draft of history, so to speak – too literally.

As Dr Shane Oliver, of AMP Capital, reminds us, the annual growth figure is artificially strong because the contraction of 0.3 per cent in the September quarter of last year dropped out of the annual calculation, whereas the 0.9 per cent bounce back in following quarter stayed in.

The bureau's trend (smoothed seasonally adjusted) estimates show growth of 2.4 per cent over the year to September, which is probably closer to the truth.

That compares with the economy's "potential" (maximum average rate of growth over the medium term, without rising inflation pressure) of 2.75 per cent a year. And with the Reserve Bank's forecast that growth over next calendar year will reach 3 per cent.

Since growth has fallen short of its potential rate for so long – creating plenty of spare production capacity – the economy can (and often does) grow faster than its medium-term "speed limit" for a few years without overheating.

And, although the latest reading isn't all that wonderful, there are enough good signs among the bad to leave intact the Reserve's forecast of better times next year.

(Remember, however, that much of the growth in all the figures I've quoted – and will go on to quote – comes from a simple, but often unacknowledged, source: growth in the population. The bureau's trend estimates show real GDP per person of just 0.3 per cent during the quarter and just 0.9 per cent over the year.)

Getting to the detail, we'll start with the bad news. Consumer spending – which accounts for well over half of GDP - grew by a minuscule 0.1 per cent during the quarter, and by a weak 2.2 per cent over the year to September.

Why? Because, despite remarkably strong growth in the number of people earning incomes from jobs, the increase in people's wages is unusually low – as measured by the national accounts, even lower than the 2 per cent registered by the wage price index.

Until now, households have been cutting their rate of saving so as to keep their consumption spending growing faster than their disposable (after-tax) income. They've probably been encouraged in this by the knowledge that the value of their homes has been rising rapidly, thus making them feel wealthier.

Now, however, Melbourne house prices are rising more moderately, while Sydney prices are falling a little. Price rises in other state capitals have long been more modest.

In the latest quarter, households' income rose faster than their consumption spending, meaning they increased their rate of saving. It's possible people have become more conscious of our record level of household (mainly housing) debt – though this is probably taking the (particularly dodgy) quarter-to-quarter changes too literally.

Next bit of bad news is that the boom in home building has finally topped out, with activity falling by 1 per cent in the quarter and by 2.3 per cent over the year.

There are a lot of already-approved apartments yet to be built, however. So, though home building's addition to growth has finished, it's future subtraction from growth shouldn't be great.

Which brings us to the first bit of good news. While investment in new housing has peaked, business investment in equipment and structures in the (huge) non-mining part of the economy is finally getting up steam.

According to estimates from Felicity Emmett, of ANZ bank, non-mining business investment rose by 2.7 per cent in the quarter, and by 14 per cent over the year.

The figures for business investment spending overall are even stronger, meaning spending in mining has been growing somewhat, not continuing to fall.

This doesn't mean mining investment has hit bottom, however. Higher commodity prices are prompting some minor investment, but there's a last minus yet to come from the completion of some big gas projects.

The other really bright spot is strong public sector investment in infrastructure – mainly road and rail projects in NSW and Victoria – which grew by 12.2 per cent over the year to September.

The external sector made no net contribution to growth, despite the volume of exports - minerals, rural, education and tourism - growing by 1.9 per cent in the quarter and by 6.4 per cent over the year.

That's because of a bounce-back in the volume of imports. Why, when consumer spending is weak? Because most investment equipment is imported.

If all these ups and downs are too equivocal to convince you the economy really is gathering strength, I have the killer argument: jobs growth.

As Morrison was proud to boast - apparently, all the new jobs are directly attributable to the government's own plan for Jobson Grothe​ - the increase in employment during the quarter was remarkable.

It rose by more than 90,000, with eight in 10 of those jobs full-time. Over the year to September, total employment rose by 335,000, an amazing increase of 2.8 per cent.

It's true the economy won't be back to its normal healthy self until wages are growing a bit faster than prices, reflecting the improvement in the productivity of labour (running at 1 per cent a year).

But an economy with such strong and sustained growth in full-time jobs simply can't be seen as sickly. And precedent tells us that where employment goes, wages follow.
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Wednesday, December 6, 2017

Latest attack on welfare 'unworthies' is contemptible

Remember the Turnbull government's plans to drug test people on the dole? While you and I are diverted by all the political game-playing in this week's last session of parliament for the year, the government is hoping to slip these and other mean-spirited cuts in social security through the Senate – probably after some deal with the Xenophon-less Xenophones.

You can blame it on my Salvo upbringing – whose influence on my values seems to get stronger the older I become – but I have nothing but contempt for comfortably-off people who try to solve their problems by picking on the down-and-out.

If Australians can't do better than that, what hope is there for us?

The expected savings (which may or may not eventuate) of $478 million over four years are minor in a budget of almost $2 trillion over the same period.

But they'll be coming out of the hides of those most in need, those whose first lack of moral discipline was failing to pick the right parents, those whose luck has been worse than ours, those who've failed to deny themselves and their children the slightest treat at any time, the way we undoubtedly would had we been in their shoes.

They're the cuts a government makes when it wants to be seen to be acting to reduce the budget deficit, but lacks the courage to take on a fight with the medical specialists, drug companies, chemists, mining companies or other powerful interest groups guarding their own, much bigger slice of budget pie.

They're also the cuts you make when you're indulging your well-off supporters' delusion that the "unsustainable" growth in welfare spending is caused by all the cheating by the undeserving poor, not the retirement of the Baby Boomers and their success in getting around the age pension means test.

To be fair, what the Coalition plans is just a step up from the harsh measures imposed by their Labor predecessors. Labor's conscience has returned only now it's back in opposition.

Labor, however, tried harder to disguise its true motive of gratifying the workers' self-righteous envy of those living the cushy life on the dole or sole parent pension.

Labor governments profess to be into tough love. Using carrots and sticks to encourage people of working age off benefits and into a job, which will bring them more money and self-respect.

But I see little of that cant from the present supposed protectors of the disadvantaged, Alan Tudge and his problematically named boss, Christian Porter.

They seem all toughness and no love. They want to be seen as the great punishers and straighteners of the hordes of lazy cheats and bludgers and ne'er-do-wells sucking the blood of all the over-taxed, hard-working upper income-earners whose self-serving interests they were elected to promote.

Consider the plan to drug test people on the dole. It seems an exercise in emotionally gratifying punishment in search of an "evidence base".

According to the Rural Doctors Association, "people who are looking for a job do not generally have any higher incidence of drug use than those in the general population".

In 2013, the government's own Australian National Council on Drugs examined the idea and recommended against it, saying "there is no evidence that drug testing welfare beneficiaries will have any positive effects for those individuals or for society, and some evidence indicating such a practice could have high social and economic costs".

Almost all the doctors and other professionals actually involved in helping drug addicts have opposed the idea. They're particularly insistent that compelling people to undergo treatment doesn't work.

They won't be testing everyone on the dole, however, that would be far too expensive. Just 5000 people. But the amount the government expects to save by denying payments to those who fail the test suggests it doesn't expect the move to have any great deterrence effect. It's just an excuse to cut people off the dole and save money.

Other pettifogging measures in the bills the government hopes to get through this week include freezing benefit rates to wives and widowed pensioners until they're no greater than the "jobseeker payment" (the latest bureaucratic euphemism for the dole), getting rid of the 14-week bereavement allowance, tightening the job search requirement for those aged 55 to 59 (who, as we all know, could find jobs if they tried) and making it easier to suspend their dole, and delaying the start of payments for some welfare recipients.

Another much-needed reform is delaying the start of dole payments until any savings people have are exhausted (then wondering why they can't pay unexpected bills on the single dole of $268 a week).

Other changes would make it easier for Centrelink to "breach" (cut payments to) people judged to have failed to comply with their "mutual obligations". There's more, but you get the idea.

I'm just waiting for the bill that sools Centrelink's robodebt recovery machine on those cabinet ministers and others who breached the Constitution by claiming to be eligible for election when they weren't, but have received months of pay to which they weren't entitled.

Apparently, the rules applying to little guys whose behaviour is less than perfect are a lot tougher than those applying to top guys deciding how tough to be on the little guys. You get the tough, we get the love.
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Monday, December 4, 2017

Politicians should get wings clipped on infrastructure

The more our ever-more "professional" politicians put political tactics ahead of economic strategy – put staying in government ahead of governing well – the more pressure they come under to cede more of their power to independent authorities.

The obvious instance is our move in the mid-1990s to transfer control over interest rates ("monetary policy") from the elected government to the independent central bank.

Shifting interest rates away from those tempted to move rates down before elections and up after them has proved far better for the stability of the economy.

Another issue on which voters don't trust politicians to make good decisions – mainly because of the risk of collusion between them – is their own remuneration.

So, first, responsibility for setting politicians' salaries, and now, their expenses, has been handed over to independent bodies.

Then there was the Gonski report's proposal that responsibility for determining the size of grants to public, Catholic and independent schools be taken away from deal-doing pollies and given to a properly constituted authority, following consistent and transparent criteria.

The idea was rejected by Julia Gillard but, particularly now the amazing variance in the deals Labor did with different school systems has been revealed under the Coalition's version of Gonski, there's still hope we'll end up with an independent, rules-based grants authority.

Some years ago, the Business Council took up a proposal by Dr Nicholas Gruen for the example set by monetary policy to be spread to fiscal (budget) policy. An independent body would set the budget's key parameters – for spending, revenue and budget balance – leaving the government to decide the specific measures to take within those parameters.

The idea didn't gain traction, but it may have boosted the push for independent evaluation of infrastructure projects.

You can see an admission that "something needs to be done" in the establishment of Infrastructure Australia by the Rudd government, and its rejig by the Abbott government, as a supposedly "independent statutory body providing independent research and advice to all levels of government".

Trouble is, the authority has little authority. Its role is to create the illusion of independent evaluation and reformed behaviour, while the reality continues unchanged.

There's no obligation for even the federal government to have all major projects evaluated, for them to be evaluated before a government commits to them and begins work, nor for those evaluations to be made public as soon as they're completed, so voters can debate the merits of particular projects with hard evidence.

Promises to build particular projects in a state, or even an electorate, are a key device all parties use to buy votes in election campaigns.

As Marion Terrill, of the Grattan Institute, has demonstrated, few of the projects promised by the government, opposition and Greens at last year's election had been ticked by Infrastructure Australia, and many of those it had ticked weren't on anyone's list of promises.

Terrill's research has revealed the huge proportion of government spending on capital works that's unlikely to yield much economic or social return to taxpayers.

For some years the Reserve Bank, backed by the International Monetary Fund and the Organisation for Economic Co-operation and Development, has argued that fiscal policy should be doing more to help monetary policy get our economy back to trend growth by spending more on worthwhile infrastructure projects. These would add to demand in the short run, and to supply capacity in the medium run by improving private sector productivity.

This changed approach would involve shifting the focus of fiscal policy from the overall budget deficit (including capital works spending) to the more meaningful recurrent or operating deficit.

This year's budget seemingly accepted this proposal, promising to give greater prominence to the NOB – net operating balance – and announcing two huge new infrastructure projects: the second Sydney airport and the Melbourne to Brisbane inland freight railway.

See the problem? Government infrastructure spending does wonders for the economy only if the money's spent on much-needed projects. As a proper evaluation would show, the inland railway is a waste of money (the product of a deal with the Nationals).

So it's little wonder that cities and infrastructure are the third big item, after healthcare and education, on the Productivity Commission's new agenda for micro-economic reform.

It's first recommendation? "It is essential that governments ensure that proposed projects are subject to benefit-cost evaluations and that these, as well as evaluations of alternative proposals for meeting objectives, are available for public scrutiny before decisions are made."

This is something the professed believers in Smaller Government, and those professing to be terribly worried about lifting our productivity, should be making much more noise about.
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Saturday, December 2, 2017

Good could come from bank royal commission

The banks and other opponents of a royal commission into banking told us it would generate a lot of noise and expense without achieving anything of value. They'll probably still be claiming that when the just-announced inquiry has reported.

Well, maybe. By contrast, I think there's a good chance the commission's establishment will be seen as the most visible marker of the time when the two sides of politics turned their backs on the era of bizonomics – the doctrine that what's good for big business is good for the economy and the punters who make it up.

The litany of misconduct by the big four banks – the unscrupulous investment advice given, the mistreatment of people with legitimate life insurance claims, the charges that the bank-bill swap rate was being rigged, and allegations of extensive use of bank facilities for money laundering – has driven the public's growing insistence that the banks be brought to account.

This week Rod Sims, boss of the Australian Competition and Consumer Commission, confirmed what all of us know, that competition in banking is weak ("not vigorous") leaving the big four with great ability to protect their excessive profits by passing costs on to their customers ("the large banks each have considerable market power").

The arguments of the banks and the Turnbull government that an inquiry must be avoided because it would shake confidence in the integrity and strength of our financial system – including in offshore markets – were just as weak then as they are now when used by the banks and the government to justify holding an inquiry to end the "political uncertainty".

The plain truth is that a rebellion by its own backbenchers has robbed the government of its ability to stop an inquiry going ahead.

This is the best explanation for the banks' sudden reversal from opposing an inquiry to claiming one is now "imperative". Since the revolt makes one inevitable, they'd prefer its establishment to be controlled by their Liberal defenders, not their Nationals, Greens and Labor critics.

They say a smart prime minister never commissions a report unless he knows what it will find and recommend. But that's easier imagined than achieved.

Were the commission's report to be judged by voters as a whitewash, with no significant consequences, this would simply ensure the bad behaviour of the banks remained a hot issue favouring the government's opponents at the next election.

What's just as likely is that royal commissioner Kenneth Hayne will interpret his terms of reference as he sees fit and, in any event, uncover a lot more instances of misconduct.

Broadening the inquiry's scope to cover misconduct in wealth management, superannuation and insurance, as well as in banking proper, is unlikely to leave voters thinking the banks' behaviour hasn't been as bad as they first thought.

Polling shows high public support for a banking royal commission, including among Coalition voters.

But the way the government has been forced by public opinion to abandon its attempt to protect the banks is a sign of much deeper public disaffection with the long-dominant "neoliberal" doctrine – formerly accepted by both sides of politics – that governments should do as little as possible to prevent businesses doing just as they see fit.

That when business mistreats its customers or it employees, there's nothing the government could or would want to do.

That big businesses' generous donations to both sides' coffers mean they have the politicians in their pockets. That the Turnbull government's desire to cut the rate of company tax on foreign multinationals that already avoid paying much is proof the economy's run to please the big boys, not you and me.

I've been writing for months about the breakdown of the "neoliberal consensus". This is evident in the way the Labor side has promised a banking royal commission, opposed big business tax cuts, opposed reductions in penalty rates, and pressed for constraints on negative gearing and the capital gains tax discount.

But set aside his resistance to a banking inquiry and (impotent) advocacy of big business tax cuts, and you see Turnbull's already doing much to respond to voters' rejection of the fruits of neoliberalism – privatisation, the various economic reform stuff-ups – with his new tax on multinational tax avoiders and coercion of particular companies in his struggle to fix the stuffed-up national electricity market and the cornering of the eastern seaboard gas market by three big companies.

Remember too the way, as part of his efforts to stave off a banking inquiry, Turnbull has become ever tougher on the banks, making them pay for more surveillance by the Australian Securities and Investments Commission and imposing a new tax on the five biggest of them.

In his most recent attempt to head off pressure for an inquiry, a proposed arrangement to compensate victims of bank misbehaviour, the banks would have been paying.

When the political smarties look back on this saga, my guess is they'll conclude Turnbull was mad to lose so much political credit in his abortive attempt to protect the banks from the public's disapproval of their greed-driven misbehaviour.

He should have got, much earlier than he did, the message that the era of governments pandering to big business was over, killed off by voters' disaffection with the political mainstream and willingness to flirt with the populist fringe.

I'm not sure Australia's big business has yet got that message, particularly not the big banks – transfixed as they are by their inward-looking contest to increase their profits and chief executive remuneration package by more than their three rivals have.

I support the royal commission because another year or more of public dredging through all the moral (and sometimes legal) shortcuts the banks have taken on their way to higher profits and bonuses may finally get the message through that their way of doing business – and treating their customers – must change.
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Wednesday, November 29, 2017

The real reason you're feeling the pinch

Maybe it's just me, but these days the more politics I hear on TV or radio, the less time it takes for my blood to boil. Just ask my gym buddies. "No point shouting at the radio, Ross, they can't hear you."

Last week, for instance, I heard the erstwhile Queensland leader of One Nation carrying on about what a big election issue the rising cost of living was. There was the cost of electricity ... but he ran out of examples.

High on my list of things I hate about modern pollies is the way they tell us what they think we want to hear, not what we need to know. Then they wonder why voters think they're phoneys.

As someone who's spent his career trying to help people understand what's going on in the economy, it's galling to hear politicians reinforcing the public's most uncomprehending perceptions.

The crazy thing is, the widespread view that our big problem is the rapidly rising cost of living is roughly the opposite of the truth.

It's true the price of electricity has been rising rapidly, lately and for many years, for reasons of political failure. But electricity accounts for just a few per cent of the total cost of the many goods and services we buy.

And the prices of those other things have been rising surprising slowly, with many prices actually falling. You hadn't noticed? Goes to show how wonky your economic antennae have become.

Annual increases in consumer prices have been so low for the past three years that the governor of the Reserve Bank, Dr Philip Lowe, is worried about how he can get inflation up into his target zone of 2 to 3 per cent.

Why would anyone worry that the cost of living isn't rising fast enough? Because, though it's hardly a problem in itself, it's a symptom of a problem buried deeper.

Which is? Weak growth in wages over the past four years. Rising wages are the main cause of rising prices. Price rises have been small because wage rises have been small.

It's the weak growth in wages that's giving people trouble balancing their household budgets – a problem they mistakenly attribute to a fast-rising cost of living.

What they've grown used to over many years is wages rising by a per cent or so each year faster than prices, and they've unconsciously built that expectation into their spending habits. When it doesn't happen, they feel the pinch.

For the past four years, wages have barely kept pace with the weak – about 2 per cent a year – rise in consumer prices.

This absence of "real" wage growth is a problem for age pensioners as well as workers because pensions are indexed to average weekly earnings – meaning they too usually rise each year by a per cent or so faster than prices.

Why would any economist worry that wages weren't growing fast enough? Because, as well as being a cost to business, wages are the greatest source of income for Australia's 9.2 million households.

And when the growth in household income is weak, so is the growth in the greatest contributor to the economy's overall growth: consumer spending.

It might seem good for business profits in the short-term, but weak wage growth eventually is a recipe for weak consumption and weak growth in employment. What sounded like a great idea at first, ends up biting business in the bum.

Weak wage and price growth is a problem in most rich countries at present, meaning it's probably explained by worldwide factors such as globalisation and technological change.

In a speech last week, Lowe opined that a big part of the problem was "perceptions of increased competition" by both workers and businesses.

"Many workers feel there is more competition out there, sometimes from workers and sometimes because of advances in technology" and this, together with changes in the nature of work and bargaining arrangements, "mean that many workers feel like they have less bargaining power than they once did".

"It is likely that there is also something happening on the firms' side as well . . . Businesses are not bidding up wages in the way they might once have. This is partly because business, too, feels the pressure of increased competition."

Lowe says a good example of this process is increased competition in retailing, where competition from new entrants (Aldi, for instance) is putting pressure on margins and forcing existing retailers to find ways to lower their cost structures.

Technology is helping them do this, including by automating processes and streamlining logistics (transport costs). The result is lower prices.

"For some years now, the rate of increase in food prices has been unusually low. A large part of the story here is increased competition. The same story is playing out in other parts of retailing. Over recent times, the prices of many consumer goods – including clothing, furniture and household appliances – have been falling," Lowe says.

"Increased competition and changes in technology are driving down the prices of many of the things we buy. This is making for a tough environment for many in the retail industry, but for consumers, lower prices are good news."

True. Which is why I find it so frustrating when idiot politicians keep telling people the cost of living is soaring.
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Monday, November 27, 2017

Tax cuts: lies, damn lies and bracket creep

If Malcolm Turnbull's promised tax cuts ever eventuate, we can be sure they'll be justified in the name of redressing terrible "bracket creep". But there are few aspects of taxation that involve more deception.

Treasury has been overselling the bracket creep story since the arrival of the Abbott government, while the Turnbull government has been exaggerating how much of it there's likely to be, so as to prop up its claim it's still on track to return the budget to surplus in 2020-21.

Every politician with their head screwed on loves bracket creep. When pressed, however, all profess to think it a bad thing. The punters think they disapprove of it, but their "revealed preference", as economists say (what they do rather than what they say), tells us they prefer it to the alternative.

It's only commentators like me who are free to say openly that, in this imperfect world, bracket creep's a jolly good thing and there ought always to be a fair bit of it.

Bracket creep occurs when a taxpayer's income increases by any amount for any reason. That's because we have a progressive income tax scale – one where successive slices of income are taxed at higher rates in the dollar – that's fixed in nominal terms.

Sometimes the creep happens because the increase in income lifts the last part of someone's income into a higher tax bracket, but it occurs even if this isn't the case. That's because the higher proportion of their income that's taxed at their highest ("marginal") tax rate increases the average rate of tax they're paying on the whole of their income.

If politicians really disapproved of bracket creep they could eliminate it by indexing the tax scale's bracket limits on July 1 each year in line with the rate of inflation in the previous financial year.

If you wanted to allow only for the effect of inflation, you'd index the brackets to the consumer price index. If you were a true believer in Smaller Government, who thought it a crime for a person's rising real income to raise their average rate of tax, you'd index it to average weekly earnings.

That no government has indexed the tax scale in this way since Malcolm Fraser's abortive experiment with it in the late 1970s is all the proof you need that, whatever they say, politicians of both colours quite like bracket creep. Same goes for Treasury.

The pollies' preference is to let it rip, but then make big guys of themselves by giving some of it back about once every three years, just before or just after an election. Only during the first half of the resources boom, when their coffers were (temporarily) overflowing, did John Howard and Peter Costello depart from this approach.

I believe in bracket creep because it's always played a vital role in helping to balance the budget. It's part of the implicit contract between governors and the governed, who want ever-growing government spending, but don't like explicit tax increases, particularly new taxes.

Their unspoken message to governments is: you find a way to pay for the spending we want, just don't wave it in front of our faces. Bracket creep is the tried and true way of squaring this circle, with limited objection from taxpayers.

What few people seem to realise at present, however, is that we've had precious little bracket creep for the past four years because inflation has been unusually low, and wages have barely kept up with it.

Limited bracket creep is the greatest single reason the Coalition government has had so little success in returning the budget to surplus. The government's persistent over-estimation of the bracket creep that will come its way is the main reason it has kept failing to reduce the deficit as forecast.

Yet throughout this government's term, official estimates of the huge extent of future bracket creep have been published, seemingly making the case for big tax cuts. The latest, issued last month by the Parliamentary Budget Office, were reported as though they were established (and scandalous) fact.

In truth, they were mere projections, based on this year's budget projections that wage growth will accelerate to 3.75 per cent a year over the next three years – projections that have been pilloried as wildly optimistic.

I'll let you into a secret unknown to the innumerate end of the media: if your big economic problem is exceptionally weak wage growth, one problem you don't need to worry about is excessive bracket creep. Nor is there any urgent case for tax cuts.
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Saturday, November 25, 2017

Economic garden gets back to normal - very slowly

With the year rapidly drawing to a close, the chief manager of the economy has given us a good summary of where it looks like going next year. The word is: we're getting back to normal, but it's taking a lot longer than expected.

The chief manager of the economy is, of course, Reserve Bank governor Dr Philip Lowe, and he gave a speech this week.

For years Lowe and others have been tell us the economy is making a difficult "transition" from the resources boom to growth driven by all the other industries. But now, he says, it's time to move to a new narrative.

"The wind-down of mining investment is now all but complete, with work soon to be finished on some of the large liquefied natural gas projects," he says.

Mining investment spending rose to a peak of about 9 per cent of gross domestic product in 2013, but is now back to a more normal 2 per cent or so.

This precipitous fall has been a big drag on the economy's overall growth, meaning its cessation will leave the economy growing faster than it has been.

As Lowe puts it, "this transition to lower levels of mining investment was masking an underlying improvement in the Australian economy". The decline in mining investment also generated substantial "negative spillovers" to other industries, particularly in Queensland and Western Australia.

This is a good point: weakness in the mining states has made the figures for the national economy look below par, even though NSW and Victoria have been growing quite strongly.

The good news, however, is that these negative spillovers are now fading. In Queensland, the jobs market began to improve in 2015, and in WA conditions in the jobs market have improved noticeably since late last year.

This is one reason Lowe expects the economy's growth to strengthen next year. Another is the higher volume of resource exports as a result of all the mining investment.

"We expect GDP growth to pick up to average a bit above 3 per cent over 2018 and 2019." This may not sound much, but "if these forecasts are realised, it would represent a better outcome than has been achieved for some years now.

"This more positive outlook is being supported by an improving world economy, low interest rates, strong population growth and increased public spending on infrastructure," he says.

And the outlook for business investment spending has brightened. "For a number of years, we were repeatedly disappointed that non-mining business investment was not picking up . . .

"Now, though, a gentle upswing in business investment does seem to be taking place and the forward indicators [indicators of what's to come] suggest that this will continue.

"It's too early to say that animal spirits have returned with gusto. But more firms are reporting that economic conditions have improved and more are now prepared to take a risk and invest in new assets."

The improvement in the business environment is also reflected in strong employment growth. Business is feeling better than it has for some time and is lifting its capital spending as well as creating more jobs.

Over the past year, the number of people with jobs has increased by about 3 per cent, the fastest rate of increase since the global financial crisis.

The pick-up is evident across the country and has been strongest in the household services (which include healthcare, aged care and education and training) and construction industries.

It's also leading to a pick-up in participation in the labour force, especially by women.

So, everything in the economic garden is back to being lovely?

No, not quite. Consumer spending – by far the biggest component of GDP – "remains fairly soft". It's been weaker than its annual forecast since 2011 and hasn't exceeded 3 per cent for quite a few years.

Why? Because of weak growth in real household income and our very high level of household debt. The weak growth in household income is explained mainly by the weak growth in wages for the past four years, which have barely kept pace with (unusually low) inflation.

Lowe says "an important issue shaping the future is how these cross-cutting themes are resolved: businesses feel better than they have for some time but consumers feel weighed down by weak income growth and high debt levels".

Let me be franker than the governor. The economy won't get back to anything like normal until we get back to the modest rate of real (above inflation) growth in wages we've long been used to.

Just what's causing the weakness in prices as well as wages – which is a problem occurring in most other developed economies – and whether the problem is temporary or lasting, is a question that's hotly debated, with Lowe adding a few pointers of his own.

He thinks it's partly temporary, meaning wage growth will soon pick up from its present (nominal) 2 per cent a year, and partly longer-lasting, meaning it may be a long time before it returns to its usual 3½ to 4 per cent.

"We expect inflation to pick up, but to do so only gradually. By the end of our two-year forecast period, inflation is expected to reach about 2 per cent in underlying terms . . . Underpinning this expected lift in inflation is a gradual increase in wage growth in response to the tighter labour market."

Here's his summing up:

"Our central scenario is that the increased willingness of business to invest and employ people will lead to a gradual increase in growth of consumer spending. As employment increases, so too will household income. Some increase in wage growth will also support household income.

"Given these factors, the central forecast is for consumption growth to pick up to around the 3 per cent mark" – which would still be below what was normal before the GFC.
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Wednesday, November 22, 2017

Tax cuts would have cons and pros

Yippee! It's almost Christmas and Malcolm Turnbull has dropped a big hint that tax cuts are coming. Good old rich Uncle Mal has been to see his bank manager, got the overdraft extended, and is determined we'll all have a great Chrissie, no matter what.

Actually, it's all a bit vague at this stage. We don't yet know whether the cuts will even be announced before Christmas, let alone when they'll be delivered. Nor do we have any idea whether they'll be large, small or indifferent.

Wouldn't surprise me if they were on the small side, nor if we got them only as a reward for voting Turnbull back into office at the next election, to be held late next year or in the middle of 2019.

All we actually know is what Turnbull dropped into a speech to the Business Council after affirming his intention to press on with the hugely expensive company tax cuts for big business.

"In the personal income tax space, I am actively working with the Treasurer and my cabinet colleagues to ease the burden on middle-income Australians, while also meeting our commitment to return the budget to surplus," he said.

It wouldn't surprise me if even Turnbull doesn't yet have a clear idea about the size and timing of the cuts. That will depend partly on Treasury's grudging willingness to make it seem they can be afforded "while also meeting our commitment to return the budget to surplus", but just as much on the calculations of his spin doctors.

Will they decide to announce the cuts soon, using them as an attempt to break the circuit of negative media discussion of some problem the government's having, or keep them under wraps until much closer to the time when voters are asked to show their gratitude at the polls?

That Turnbull has dropped the big hint this early in the piece is a sign they're more likely to be chewed up in a desperate but futile attempt to give the government some "clear air", than carefully preserved as part of a grand re-election strategy.

But though uncertainty abounds, there are three iron laws of tax cuts.

The first is that a government's motive in making them is always mainly political. It either fears that if it doesn't cut it will lose votes – because voters are starting to resent how much tax they're paying on any pay rises or overtime – or it hopes if it does cut this will win votes in thanks for its magnanimity.

The second law is that, despite their political motivation, tax cuts always come colourfully wrapped in wonderful economic justifications. By taking this political gift, we're assured, we'll be creating jobs, reducing unemployment and making the economy grow.

It's almost our economic duty to accept the offer of the bloke selling tax cuts for votes.

The third law, however, is that voters' gratitude for being given a little of their own money back is faint to non-existent. A tax cut announced is soon forgotten; a tax cut delivered before an election has next to no influence on the outcome.

But can the budget afford tax cuts? Not if you accept the government's preferred way of measuring the deficit. It says we're still a long way from returning the budget to balance.

The government's prediction we'll be back to budget surplus by 2021 rests heavily on its forecast that wages will soon start growing strongly, much faster than inflation. Maybe.

If Treasury finds a way to maintain that trajectory while paying for tax cuts, it will be by stepping up its over-optimistic forecasts of wage growth. With circular logic, the "bracket creep" such forecasts imply would then be used to justify the tax cuts themselves.

For years we've been told a government that needs to borrow each month to keep itself afloat can't possibly afford to give aid to poor people overseas. But borrowing to cover tax cuts to big business isn't a problem nor, apparently, is borrowing to give voters a tax cut.

The sad truth is that this Abbott-Turnbull government has got neither the conviction nor the honesty to stick to a consistent line on debt and deficits.

In opposition they told us the debt was a frightening crisis, but easily fixed by them. In government they had one go at fixing it at the expense of everyone but their own supporters, but lost public support from that moment, and since then have abandoned any serious attempt at budget repair, merely waiting like Mr Micawber for something (bracket creep) to turn up.

Now it's decided it can't wait even for that, but must give some of it back on the assumption it will turn up – eventually.

But whatever their political motivation, tax cuts do have effects on the economy, so what would they be?

At a time like this, tax cuts would have a similar effect to a decent pay rise, making it a little easier for households to keep spending, giving consumer spending a modest boost and, indeed, creating a few more jobs.

And if you defy federal Treasury and measure the budget balance more sensibly, stripping out investment in infrastructure, you find the recurrent deficit has already been largely eliminated. A small tax cut wouldn't set it too far off course.
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Monday, November 20, 2017

Labor plans further blow to Treasury power

It's a process that's gone on for so long few people have noticed it: the waning influence of the once-mighty federal Treasury.

There was a time, 40 years ago, when Treasury sought to monopolise the economic advice going to the federal government. But those days are long gone.

The peak of Treasury's influence came with the sweeping micro-economic reforms and opening up of the economy in the 1980s and 1990s. It first convinced its minister, John Howard, of the need for widespread reform, but he made little progress under Malcolm Fraser.

Under a much more sympathetic Bob Hawke, Howard's successor as treasurer, Paul Keating, delivered on Treasury's reform agenda beyond its wildest dreams.

Since 2000, after Howard as prime minister won Treasury's 25-year battle to introduce a broad-based consumption tax, it's been largely downhill all the way on micro reform, with its loss of momentum, direction and purity of motive.

This is what's so significant about the Productivity Commission recently seizing the initiative to Shift the Dial and revive and redirect the reform agenda. Its "new policy model" could never have come from a tired and hidebound Treasury.

When Fraser sought to punish Treasury in 1976 by dividing it in two, Treasury and Finance, the initial judgment was that he'd succeeded only in doubling its vote in favour of budget rectitude at the cabinet table.

Forty years on, I now doubt that. Its bifurcation has diminished Treasury's effectiveness in the endlessly recurring task of "fiscal consolidation" (getting the budget deficit down) by robbing it of both the expertise and the motivation to find innovative, politically sustainable ways to limit the growth in government spending.

This trickier side of the budget has largely been left in the hands of the Finance accountants, whose vision rarely extends beyond this year's budget task, and who know more about creative accounting than the wider economic consequences of their crude spending cuts.

On the revenue side, Treasury shares the Business Council's unending obsession with tax reform. Why? To a surprising extent, for the simple, institutional reason that tax policy still lies within its own ministerial responsibility.

Treasury's become more inward looking and less concerned to oversee ("co-ordinate") the activities of other departments.

With one glaring exception. Treasury's greatest loss of influence came with the recognition of Reserve Bank independence in the mid-1990s.

From that time, the day-to-day management of the macro economy moved to the Reserve, with Treasury merely retaining a seat on the bank board and the ear of the treasurer.

Yet there's been great reluctance on Treasury's part to acknowledge this loss of power. It pretends nothing's changed, devoting far too many of its shrinking human resources to second-guessing the Reserve.

The Reserve devotes many resources to "liaison" (gathering businesses' views on the state of the economy), so Treasury must do it too.

The Reserve has an extensive forecasting round each quarter, so Treasury must do its own – but half-yearly, because its only actual forecasting need is for a set of macro-economic "parameters" to plug into its budget estimates of spending and revenue.

The Reserve regularly investigates the latest macro puzzle – say, why non-mining business investment is so slow to recover – so Treasury must do its own. Its new Treasury Research Institute focuses on macro management issues.

What gets neglected is Treasury's oversight of the big micro reform issues. Think health, education, infrastructure. Without an institutional understanding of the detail of these areas, Treasury simply isn't up to speed on either micro reform or budget sustainability.

So its recent establishment of a "structural reform" division seems a step in the right direction – until you learn that the group's first big project was to inquire into non-mining business investment's slowness to recover.

Another part of Treasury's decline is its politicisation, particularly Tony Abbott's decision to sack the Treasury secretary, Dr Martin Parkinson, and replace him with someone whose views he felt more comfortable with, John Fraser.

Recent Coalition governments have preferred Treasury and other departments to be less the fearless policy advisers and more the handmaidens to the minister and their office.

This politicisation makes it ever-harder to believe Treasury's persistently over-optimistic economic and budget forecasts are the product of forecaster fallibility rather than political interference.

Trouble is, the more your influence and authority decline, the more people want to take a crack at you.

Should Labor win the next election, it says it will shift responsibility for budget forecasting and the five-yearly intergenerational report (whose credibility Joe Hockey destroyed by turning it into a political tract) from Treasury to the more independent Parliamentary Budget Office.
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Saturday, November 18, 2017

Unis should never be allowed to set their own fees

The Productivity Commission has changed its ideological tune, shifting away from the slavish adherence to an idealised version of the "neoclassical" model of the economy for which it and its predecessors became notorious.
It's moved to a more nuanced approach, recognising the many respects in which real-world markets differ from those described in elementary textbooks.
This shift has been underway since the present chairman of the commission, Peter Harris, succeeded Gary Banks in 2012.
You could see it in the commission's 2015 report on the Workplace Relations Framework, which acknowledged, readily and in detail, the factors that made the simple neoclassical, demand-and-supply model unsuitable for analysing the labour market.
But it's even more apparent in the commission's blueprint for a very different approach to economic reform, Shifting the Dial. Consider this.
Remember the plan in the Abbott government's first budget, of 2014, to deregulate the fees universities are allowed to charge students doing undergraduate degrees?
It was a logical next step following the Gillard government's decision some years earlier to deregulate the number of undergraduate places each university was permitted to offer.
The unis had responded by hugely increasing the number of government-funded places, at greatly increased cost to the federal budget, after successive governments had spent decades trying to quietly privatise the unis and get them off the budget.
The economic rationale was that "market forces" – competition between the unis – would prevent them for using their new fee-setting power to overcharge students.
It was a reform that all right-thinking people should support, and those terrible popularity-seekers in the Senate should never have blocked.
Get this: as part of its plan to improve the teaching of uni students, and in the course of explaining how some students are being charged higher fees than they should be, the commission also shows why deregulating fees would have been a crazy idea.
At the same time as it allowed unis to set their own fees, the government's intention had been to cut its funding of places by 20 per cent. It wasn't hard to see that, as unis continued to raise their fees each year, the government would keep cutting its own funding contribution until it was no more.
The commission argues (on page 109) that government "regulation" of the maximum fees unis may charge for particular undergrad courses "is necessary because price competition [between universities] is difficult to establish in the domestic university market.
"This is primarily because the vast majority of domestic students have access to income-contingent HELP loans and consequently have a low price sensitivity, which was a necessary by-product of enabling university access on merit, rather than family income."
Get it? The elementary model's promise that "market forces" – competition between sellers, plus the self-interest of buyers – will stop firms overcharging rests on an assumption that customers have to pay the price upfront.
In the case of uni fees, however, the upfront price is paid by the government, and students incur a debt to the government, which they don't have to start repaying until their income reaches a certain level at some uncertain time in the future.
How long they'll be given to repay the debt is also uncertain, though it's certain their repayments will be geared to their ability to pay, and the only interest they'll pay is the rate of inflation. Cushiest loan you'll ever get.
With the cost of university tuition to a student so far into the future and so uncertain, it's unrealistic to assume students will shop around to find the lowest-charging uni. (Actually, they all charge the maximum allowed.)
Remember, too, that the fee is less than the full cost of the tuition, meaning the unis are "selling" a product whose retail price has been heavily subsidised by the government.
The commission notes that price competition is further limited by the geographic immobility of students. Because more than 80 per cent of commencing students live at home, and moving out would add greatly to their costs, you might get competition between the unis in a particular capital city, but that's all.
But even that's unlikely. The elementary model assumes "perfect knowledge" – both buyers and sellers know all they need to know about the prices and qualities of the products on offer.
In reality, knowledge is far from complete, and is often "asymmetric" – sellers know far more than buyers, usually because the sellers are professionals, whereas the buyers are amateurs.
The commission explains why all unis – big-name or bad-name, city or country – charge the maximum fees allowed.
"In the absence of good information, lower prices may undermine the prestige of a university and its capacity to attract good students," the commission says.
This is an admission of a weakness in the elementary model that affects far more than uni fees. The assumption of perfect knowledge leads to the further assumption that the prices market forces allow a firm to charge fully reflect the quality of its products relative to the quality of rival products.
As behavioural economists have pointed out, however, quality is something that's often very hard for buyers to know in advance. Only after they've bought it and tried it will they know. Think bottles of wine.
So whereas economists assume buyers' foreknowledge of differences in quality is what determines differences in the prices of similar products, buyers who don't know the differences in quality assume they can use prices as a quality indicator. Higher price equals higher quality.
So why don't lesser unis seek to attract more students by charging lower fees than the big boys? Because it would be taken as an admission of their inferior quality, and could lose as many customers as it attracted, maybe more.
The assumption that market forces would prevent unis from abusing their freedom to set fees as they chose was extraordinarily naive, as the commission is now happy to explain.
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Wednesday, November 15, 2017

What we can do to cure affluenza

If our grandparents could see us now, what would they think? They'd be amazed by our affluence, but shocked by our wastefulness.

You'd never know it to hear us grousing about the cost of living, but most of us are living more prosperous, comfortable, even opulent lives than Australians have ever lived.

We live in a consumer society, surrounded by our possessions. We're always buying more stuff, more gadgets, an extra car, more TVs for other rooms, more laptops, iPads and smartphones.

We update to the latest model, even though the old one's working fine, and make sure our car is never more than a few years old.

We buy new clothes all the time – a lot on impulse – filling our wardrobes with stuff we wear rarely, if ever.

We buy more food than we can eat, chucking it out when it's no longer fresh so we can buy another lot.

Why do we keep buying and buying? Short answer: because we can afford to. Long answer: because, for a host of reasons, we've become addicted to consumption, whether or not it provides lasting satisfaction. We suffer from "affluenza".

Many of us engage in "conspicuous consumption" so as to impress other people with our wealth – with how well we're doing in the materialist race. Can't have the neighbours thinking we can't afford the latest model.

Other people use their hairstyles or the clothes they wear to express their individuality or, paradoxically, to signal their membership of a particular tribe.

I heard about a partner in a law firm remarking with disapproval that whenever any young person was made a partner they immediately went out and bought a black Volvo. But, someone asked, don't you have a black Volvo yourself? Oh, no, he said, mine's blue.

In his new book Curing Affluenza, Richard Denniss, chief economist of The Australia Institute, observes that, these days, much consumption is done for symbolic, signalling reasons, not because we actually need the stuff.

And then there's retail therapy – stuff we buy purely for the fleeting thrill we get from buying some new thing.

If something's telling you all this needless consumption can't be a good thing, you're not wrong. What's less obvious is why: because of the damage it does to the natural environment.

Not only the extra emissions of greenhouse gasses, but also excessive use of natural resources – both non-renewable and renewable, when usage exceeds the rate at which they can be renewed (think fish in the sea).

The richest 15 per cent of the globe's 7.6 billion population can continue living the high life only for as long as we have the wealth to commandeer more and more of the other 85 per cent's share of the world's natural resources.

But as the world's poor, led by India and China, succeed in raising their material living standards towards ours, this will get ever harder. It is not physically possible for all the world's population to live the wasteful lives we do. Nothing like all the world's population.

How can we stop using more than our fair share of the globe's natural resources? Denniss says we can start by distinguishing between consumerism, which is bad, and materialism, which isn't. Huh?

He defines consumerism as the love of buying things, whereas materialism is just the love of things. Meaning the latter is a cure for the former. The more we love and care for the stuff we've already got, repairing it when it breaks, the less we're tempted to buy things we don't need.

It's true the capitalist system invests heavily in marketing and advertising to con us into believing we need to buy more and more stuff.

But we're free to resist the system's blandishments. Indeed, I often think the people most successful in the system are those who most resist.

Unusually for an economist, Denniss argues that much of what we do – and buy – we do for cultural reasons. Because it's the normal, accepted thing to do.

But, just as our grandparents weren't as spendthrift as we are, culture can change. And you need less than a majority of people changing their behaviour to reach the critical mass that prompts most other people to join them and, by doing so, cause an improvement in the culture.

If we all stopped buying stuff we don't need, however, wouldn't that cause economic growth to falter and unemployment to shoot up?

Yes it would – if that's all we did. The trick is that every dollar we spend helps to create jobs. So we need to keep spending, but we don't need to keep spending wastefully.

There are a host of things we could spend on – better health, better education, better public infrastructure, better lives for the disabled and the elderly, less congestion, less pollution – that would yield us more satisfaction while doing less damage to the environment.

I have a feeling, however, that the cure to affluenza will require more than just changed behaviour by enough individuals. We replace rather than repair many things because the cost of repairers' labour greatly exceeds the cost of the material parts we throw away.

We need to rejig the tax system so we reduce the tax on "goods" – labour income – and increase the tax on "bads" – use of natural resources.
Read more >>

Monday, November 13, 2017

Econocrats are giving up on smaller government

You may not have noticed, but the Productivity Commission's search for "a new policy model" for reform, in reaction to the breakdown of the politicians' "neoliberal consensus", offers better prospects for finally getting the budget under control.

That's because, although the commission doesn't say so, its reformed approach to reform represents a retreat from a central tenet of neoliberal doctrine for the past 30 years: the goal of Smaller Government.

The retreat makes sense for three reasons. First, because attempts to reduce government's role in the economy – think privatisation, deregulation and cuts in government spending – are central to the populist revolt against neoliberalism.

Second, because the smaller-government push has had little success and, particularly in recent times, some spectacular failures – think the attempt to reform TAFE by making vocational education and training "contestable" by for-profit providers, which the commission now admits was a "disastrous intervention".

Third, because, paradoxically, abandoning the goal of smaller government offers a better prospect of budget repair and a return to "fiscal sustainability" (low public debt) via greater control of government spending over the medium term and a lifting of the fatwa against explicit tax increases.

That's partly because, as we've learnt since the ill-fated 2014 budget, the electoral opposition to significant cuts in spending on social security (read the age pension), healthcare and education actually exceeds the resistance to hypothecated tax increases (those linked to worthy spending programs).

But it's also because, as we've known for decades, but chosen to ignore, there's little empirical evidence of a correlation between the size of a country's public sector and its rate of economic growth or macro-economic stability.

Nor has there ever been much empirical evidence that the willingness of high income-earners to work hard - as opposed to "secondary earners" (mainly married women choosing between part-time and full-time work) – is greatly diminished by high rates of income tax.

If there's little evidence favouring smaller government, why's it been central to the neoliberal project? Because a presumption against government intervention is built into the assumptions of the economists' neoclassical model, and because limiting the size of government minimises the taxes and maximises the freedom of the rich and powerful.

The Productivity Commission's new reform agenda unconsciously reveals how much the old agenda of the past 30 years was influenced – and constrained – by the goal of smaller government.

If you're trying to improve productivity, there are two broad approaches. One is to reduce the role of government by privatising government-owned businesses (including natural monopolies), outsourcing the provision of government services, reducing government regulation and reforming taxation in ways believed to improve incentives to work, save and invest.

The alternative approach is to focus on ensuring the nation's education and training system delivers the best skill formation possible – including those skills most useful in the digital economy – and on ensuring spending on public infrastructure is both sufficient and sufficiently well directed to maximise the private sector's productivity, particularly in the big cities.

Get it? The commission's new reform agenda approaches productivity improvement more directly, accepting that the old agenda is well into diminishing returns. In the process it's shifted the goal from smaller government to better government.

The great side benefit of the commission's new policy model is that, as well as seeking to give micro-economic reform a new direction, it improves governments' chances of regaining control over their spending.

As successive federal and state intergenerational reports have shown, by far the greatest source of future growth in combined federal and state spending will be healthcare. The second biggest area of combined spending is on education and training.

The standard, Treasury and Finance-promoted approach to restraining these two spending areas adopted in the Abbott government's first budget was simply to shift a big chunk of spending off the federal budget and on to the budgets of households (the co-payment for GP visits) and the states (slashed federal grants for public hospitals and schools).

The vehemence of the public's opposition to these cuts not only rendered them impossible, it warned off governments of either stripe from trying such an approach again. Malcolm Turnbull's surprise embrace of needs-based school funding covered his retreat from cuts in grants for schools.

The alternative approach to controlling the rate of growth in spending on health and education over the medium term is to get deep into the nitty-gritty of what the respective systems do and how well they're doing it.

It's not hard to believe that improving the quality of service they deliver to patients and students could also reduce waste and inefficiency, thus slowing the rate at which their costs are growing.
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Saturday, November 11, 2017

We need better teaching at every level

It's taken an eternity, but the econocrats have finally twigged that the big problem with the nation's education and training system isn't its high-cost to budgets, but its failure to provide enough of our youth with the skills they need to get and keep a decent job.

When the Productivity Commission set out to find a "new policy model" that could "shift the dial" on productivity improvement, the penny dropped. It decided that "if we had to pick just one thing to improve ... it must be skills formation".

That's because the adoption, use and spread of new technology – the long-run drivers of productivity – require people with the right skills.

As befits its obsession with productivity, the commission doesn't bother to acknowledge that knowledge is valuable for its own sake. Humans value knowing things about their world.

But the more prosaic role of education and training is to equip people with the skills that help them earn a living.

As economists go, however, the commission's more broad-minded than most: "There is additional value in improving skills formation – from foundational to advanced – because it gives people better job security, income and job satisfaction.

"These effects are not well measured in the official statistics, but have major implications for prosperity and quality of life more broadly."

Trouble is, the commission finds our present education and training performance – from schools to vocational education and training, to universities – is falling well short of what it should be.

"A good school system ensures that people have the key foundational skills – numeracy, literacy, analytical skills – and the capacity to learn so that they can easily acquire knowledge throughout their lives," the commission says.

What shocks me most about our schools' performance is their high failure rate. Evidence the commission doesn't quote is the Mitchell Institute's estimate that 26 per cent of students fail to finish school or a vocational equivalent.

It seems so many kids have been getting behind and dropping out for so long that schools and their teachers have come to accept this as part of the natural order, not as a sign something's going badly wrong with teaching.

The commission notes that, while the regular testing under the Organisation for Economic Co-operation and Development's PISA program shows Australian school students' academic achievement is still above the OECD average, our average scientific, reading and mathematical ability is falling in absolute terms.

We've gone for decades underpaying teachers relative to other graduates, so we shouldn't be surprised our brightest people don't go into teaching.

We have a growing proportion of lower performers and a falling share of high performers. Other evidence shows our rates of participation in year 12 physics and advanced maths fell by about a third between 1992 and 2012.

One of the worst inhibitors to  gains in learning is "learner [dis]engagement" – being inattentive, noisy or anti-social. About 40 per cent of our students are involved in such unproductive behaviour.

The commission fears our youth may now be less capable than earlier cohorts. For example, an Australian 15-year-old in 2015 had a mathematical aptitude equivalent to a 14-year-old in 2000.

"Australia's growing group of low performing students will be increasingly exposed to unemployment or low participation in the future world of work," the commission says.

Its review of the evidence on school performance concludes we need to focus on improving the quality of the teaching workforce and on methods of teaching that have been proved to be more effective.

We've gone for decades underpaying teachers relative to other graduates, so we shouldn't be surprised our brightest people don't go into teaching.

Many teachers are teaching "out of field" – subjects for which they have no qualifications.

We've done too little testing of the effectiveness of different ways of teaching, and too little dissemination of the results of what testing we've done. It's obvious our classroom teaching isn't as effective as it needs to be, but we've done little about it.

The commission has less to say about the failings of VET – vocational education and training – except that it's a "mess" and still recovering from a "disastrous intervention".

This was the utterly misguided attempt to drag TAFE into the 21st century, not by doing the hard yards with the teachers union, but by applying the magic answer of "contestability" – allowing private businesses to sell taxpayer-subsidised training for profit. Many rorted the system and cheated students until the government belatedly woke up.

Turning to universities, their performance is also falling short. In 2014, more than 26 per cent of students had not completed their degree within nine years of starting – a significant loss of time, effort and money for the students, as well as taxpayers.

And this is before we see any effect from the leap in uni admissions following Julia Gillard's (misguided) decision to provide government funding for any students the unis choose to enroll.

The proportion of recent graduates finding full-time employment is falling, with the under-employment rate among recent graduates rising from 9 per cent in 2008 to more than 20 per cent.

But the fact that graduate full-time starting salaries have fallen from 90 per cent of average weekly earnings in 1989 to about 75 per cent in 2015 suggests this has more to do with the weak state of the labour market than with a decline in the quality of degrees.

Which ain't to say quality hasn't fallen. More than a quarter of recent graduates in full-time jobs believe their roles are unrelated to their studies, with their degree adding nothing to their employability.

Australian unis continue to perform poorly on student satisfaction measures relative to unis in Britain and America.

There's a lot more to the commission's critique of the unis' performance, but I'll leave that for another day.

Sufficient to say the commission has convincingly demonstrated the case for putting the quality of the nation's teaching at the top of our list of things needing urgent improvement.
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