Monday, July 31, 2023

Another rise in interest rates is enough already

Whatever decision the Reserve Bank board makes about interest rates at its meeting tomorrow morning – departing governor Dr Philip Lowe’s second-last – the stronger case is for no increase. Indeed, I agree with those business economists saying we’ve probably had too many increases already.

If so – and I hope I’m wrong – we’ll miss the “narrow path” to the sought-after “soft landing” and hit the ground with a bang. We’ll have the recession we didn’t have to have. (That’s where recession is measured not the lazy, mindless way – two successive quarters of “negative growth” – but the sensible way: a big rise in unemployment over just a year or so.)

For those too young to know why recessions are dreaded, it’s not what happens to gross domestic product that matters (it’s just a sign of the looming disaster) but what happens to people: lots of them lose their jobs, those leaving education can’t find decent jobs, and some businesses collapse.

Market economists usually focus on guessing what the Reserve will do, not saying what it should do. (That’s because they’re paid to advise their bank’s money-market traders, who are paid to lay bets on what the Reserve will do.)

That’s why it’s so notable to see people such as Deloitte Access Economics’ Stephen Smith and AMP’s Dr Shane Oliver saying the Reserve has already increased interest rates too far.

Last week’s consumer price index for the June quarter gave us strong evidence that the rate of inflation is well on the way down. After peaking at 7.8 per cent over the year to December, it’s down to 6 per cent over the year to June.

As we’ve been told repeatedly, this was “less than expected”. Yes, but by whom? Usually, the answer is: by economists in the money markets. Here’s a tip: what money-market economists were forecasting is of little interest to anyone but them.

That almost always proves what we already know: economists are hopeless at forecasting the economy. Even after the fact, and just a week before we all know the truth. No, the only expectation that matters is what the Reserve was expecting. Why? Because it’s the economist with its hand on the interest-rate lever.

So, it does matter that the Reserve was expecting annual inflation of 6.3 per cent. That is, inflation’s coming down faster than it thought. Back to the drawing board.

The Reserve takes much notice of its preferred measure of “underlying” inflation. It’s down to 5.9 per cent. But when the economy’s speeding up or slowing down, the latest annual change contains a lot of historical baggage.

This is why the Americans focus not on the annual rate of change, but the “annualised” (made annual) rate, which you get by compounding the quarterly change (or, if you can’t remember the compounding formula, by multiplying the number by four).

Have you heard all the people saying, “oh, but 6 per cent is still way above the target of 2 to 3 per cent”? Well, if you annualise the most recent information we have, that prices rose by 0.8 per cent in the June quarter, you get 3.3 per cent. Clearly, we’re making big progress.

But the next time someone tells you we’re still way above the target, ask them if they’ve ever heard of “lags”. Central Banking 101 says that monetary policy (fiddling with interest rates) takes a year or more to have its full effect, first on economic activity (growth in gross domestic product and, particularly, consumer spending), then on the rate at which prices are rising. What’s more, the length of the lag (delay) can vary.

This is why central bankers are supposed to remember that, if you keep raising rates until you’re certain you’ve done enough to get inflation down where you want it, you can be certain you’ve done too much. Expect a hard landing, not a soft one.

Since the road to lower inflation runs via slower growth in economic activity, remember this: the national accounts show real GDP slowing to growth of 0.2 per cent in the March quarter, with growth in consumer spending also slowing to 0.2 per cent.

How much slower would you like it to get?

The next weak argument for a further rate rise is: “the labour market’s still tight”. The figures for the month of June showed the rate of unemployment still stuck at a 50-year low of 3.5 per cent, with employment growing by 32,600.

But the nation’s top expert on the jobs figures is Melbourne University’s Professor Jeff Borland. He notes that, in the nine months to August last year, employment grew by an average of 55,000 a month – about double the rate pre-pandemic.

Since August, however, it’s grown by an average of 35,600 a month. Sounds like a less-tight labour market to me.

And Borland makes a further point. Whereas the employment figures measure filled jobs, the actual number of jobs can be thought of as filled jobs plus vacant jobs – which tells us how much work employers want done.

This is a better indicator of how “tight” the labour market is. And, because vacancies are falling, the growth in total jobs has slowed much faster. Since the middle of last year, part of the growth in employment has come from reducing the stock of vacancies.

Another thing the Reserve (and its money-market urgers) need to remember is that, when it comes to slowing economic activity to slow the rise in prices, interest rates (aka monetary policy) aren’t the only game in town.

Professor Ross Garnaut, also of Melbourne University, wants to remind us that “fiscal policy” (alias the budget) is doing more to help than we thought. The now-expected budget surplus of at least $20 billion means that, over the year to June 30, the federal budget pulled $20 billion more out of the economy than it put back in.

Garnaut says he likes the $20 billion surplus because, among other reasons, “we can run lower interest rates”.

One last thing the Reserve board needs to remember. Usually, when it’s jamming on the interest-rate brakes to get inflation down, the problem’s been caused by excessive growth in wages. Not this time.

Since prices took off late in 2021, wages have fallen well behind those prices. Indeed, wages haven’t got much ahead of prices for about the past decade. And while consumer prices rose by 7 per cent over the year to March, the wage price index rose by only 3.7 per cent.

This has really put the squeeze on household incomes and households’ ability to keep increasing their spending. And that’s before you get to what rising interest rates are doing.

Dear Reserve Bank board members, please remember all this tomorrow morning.

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Wellbeing? Measure what matters, then start fixing it

In this rushing world, it’s easy for the new, the exciting, the entertaining or the worrying to crowd out the merely important. But that’s one reason mastheads have columnists. To say, hey, don’t overlook this, it’s important.

If, like all sensible people, you think there’s more to life than gross domestic product – more than “the economy”, narrowly defined – you need to take more notice of Treasurer Jim Chalmers’ long-promised Measuring What Matters wellbeing framework, released on Friday.

Taken as just another news story, it was a remarkably unremarkable document. It gathered 50 statistical indicators of Australians’ wellbeing, only a few of which were the standard economic indicators.

Of these, 20 show an improvement since the early 2000s, 12 have deteriorated, while the rest have shown little change or mixed outcomes. Our headline shouted the astonishing news: “We’re living longer, but cuddly animals are on the decline.”

Meanwhile, the government’s unceasing critics had much sneering fun pointing out how outdated some figures were. Did you see they say home owners are finding it easier to repay their mortgages?

Hopeless. It’s obviously just Labor’s “pitch to progressives living in Green and teal colonies”.

Actually, it’s a genuine effort to acknowledge and pay more attention to all the aspects of our lives that matter in addition to how many of us have jobs, how much we earn and what we’re spending it on.

The people who know a lot and care a lot about our wellbeing, in all its dimensions – such as Warwick Smith, director of the Centre for Policy Development’s Wellbeing Initiative – were much less critical. They said it was a good start, and could be improved and built upon, with the ultimate objective of having our greater consciousness of these other priority areas doing more to influence what the government was spending its time trying to improve.

Few economists would disagree with the frequent claim that GDP isn’t a good measure of wellbeing or progress. Indeed, the first person to say it was the bloke who invented GDP in the 1930s, Simon Kuznets.

It’s just that, economists being economists, they’ve continued to focus on GDP – economic growth – and left the better measures of wellbeing to others. Politicians have continued to focus on economic growth because that’s what the rich and powerful care most about. They’re hoping it will make them richer and more powerful.

It’s precisely because our leaders have been so focused on GDP as a measure of economic growth that our economic statistics are comprehensive and up to date, but our measurements of other things aren’t.

So, getting fair dinkum about “measuring what matters” involves giving the Australian Bureau of Statistics more money to measure the other things that matter more fully and more frequently.

Having been a bean counter in both my careers, I know the boring, pettifogging importance of measurement. As they say, what gets measured gets managed. You want to get your map sorted before you take off into the jungle.

But what are the other, non-standard things that matter most to our wellbeing? This is what we got on Friday: the government’s decision about the key components of wellbeing. This is the wellbeing “framework”.

It nominates five dimensions of wellbeing. First, health. “A society in which people feel well and are in good physical and mental health, can access services when they need, and have the information they require to take action to improve their health,” the framework says.

Second, security. “A society where people live peacefully, feel safe, have financial security and access to housing.”

Third, sustainability. “A society that sustainably uses natural and financial resources, protects and repairs the environment and builds resilience to combat challenges.”

Fourth, cohesion. “A society that supports connections with family, friends and the community, values diversity, promotes belonging and culture.”

And finally, prosperity. “A society that has a dynamic, strong economy, invests in people’s skills and education, and provides broad opportunities for employment and well-paid, secure jobs.”

Each of these five “themes” (dimensions is a better word) are “underpinned” by the need for “inclusion, equity and fairness” (but if there’s a difference between equity and fairness, I don’t know it).

I think that covers the bases. Sounds a nice place to live. It puts the economy into a broader, more balanced context. The economy is vitally important – it’s our bread and butter, after all – but so are many other things.

If we nail it on prosperity but go backward on the others, why would that be good? The rich could survey the ruins around them and say, I won!

And there’s a lot of interdependence. Good luck with your economy once you’ve irreparably damaged the natural environment on which it depends.

On many of these dimensions, what we need to know is not so much how well we’re doing on average, but who’s missing out and needs help. Not who’s included, but who’s excluded. (Something a Voice would make it harder to forget.)

But measurement is just a means to an end. Until what we know affects what our governments do, it’s just box-ticking.


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Friday, July 28, 2023

Why inflation is easing while rents are rising - and will keep going

It never rains but it pours. With the prices of so many things in the supermarket shooting up, now it’s rents that are rising like mad. Actually, while the overall rate of inflation is clearly slowing, rents are still on the up and up. What’s going on?

The Australian Bureau of Statistics’ consumer price index (CPI) showed prices rising by 0.8 per cent over the three months to the end of June, and by 6 per cent over the year to June. That’s down from 7.8 per cent over the year to December.

But rents in Sydney rose by 7.3 per cent over the year to June, up from 3.3 per cent over the year to December. Rents in Melbourne are now up by 5 per cent, compared with 2.2 per cent to last December.

But hang on. Those increases seem low. I’ve been reading and hearing about rent increases much bigger than that. What gives?

You’ve been reading about bigger rent increases than the CPI records because what gets most notice in the media is what economists call “advertised” rents – the asking price for presently vacant properties that have been listed with real estate agents.

So, this is the most relevant price for someone who’s decided to rent, or is wishing to move. Remember, however, in normal times landlords don’t always get as much as they ask for initially. Times like now, when the market’s so tight, they may end up with more.

But, each month, only 2 or 3 per cent of properties have a change in tenants. So most people are existing renters, wanting to sit tight, not move. It’s a safe bet they’re paying less that the price being asked of new tenants. And, though their rent will be increased soon enough, it hasn’t been yet.

The stats bureau’s increases are lower than the asking price because they include the rents actually being paid by all capital-city renters, not just the new ones.

But if the asking price is a lot higher than the average of the rents being paid by everyone, this is a good sign the average will keep going up. The rent increase is working its way through the system, so to speak.

But why are asking prices rising so much? Ask any economist, and they’ll tell you without looking: if the demand for rental accommodation exceeds the supply available, prices will rise.

That’s true. And the way we know it’s true is that vacancy rates are much lower than usual.

It’s when vacancy rates are low that landlords know now would be a good time to put up the rent. If the landlord has borrowed to buy the rental property, the rise in the interest rates they’re paying will make them very keen to do so.

But more than half of all rental properties are owned debt-free. Those landlords will probably also be keen to take advantage of this (surprisingly rare) chance to increase their prices by a lot rather than a little.

When demand is outstripping supply, the economists’ knee-jerk reaction is that we need more supply. Rush out and build a lot more rental accommodation.

But the economists who actually study the rental market aren’t so sure that’s called for. If you look back over the past decade, you see little sign that the industry has had much trouble keeping the supply up with demand.

If anything, the reverse. Until the end of 2021, rents went for years without rising very fast. Especially compared with other consumer prices, and with people’s incomes. Indeed, there were times when rents actually fell.

You didn’t know that? That’s because the media didn’t tell you. Why? Because they thought you were only interested in bad news. (And they were right.)

What’s too easily forgotten is all the ructions the rental market went through during the pandemic. What’s happening now is a return to something more normal. It’s all explained in one of the bureau’s information papers.

Official surveys show that renters tend to younger and have lower incomes than homeowners, and to devote a higher share of their disposable (that is, after-tax) income to housing costs. This is why so many renters feel the recent rent rises so keenly. And also, why the pressure is greater on people renting apartments rather than houses.

The pandemic, with its changes in population flows, vacancy rates and renters’ preferences, had big effects on rents and renters. Early in the pandemic, demand for rental properties in the inner-city markets (that is, within 12.5 kilometres of the CBD) of Sydney and Melbourne declined, as international students returned home, international migration stopped and some young adults moved back in with their parents.

Some landlords offering short-term holiday rentals switched to offering longer-term rental, further increasing the supply of rental accommodation. And the need to work from home prompted some renters to move from the inner city to suburbs further out, where the same money bought more space.

This is why inner-city rents fell during the first two years of the pandemic. Also, state governments introduced arrangements helping tenants who’d become unemployed or lost income to negotiate temporary rent reductions.

But inner-city rental markets began tightening up in late 2021, as the lockdowns ended and things began returning to normal. Some singles who’d gone back home or packed into a share house began seeking something less crowded. And, eventually, international students began returning.

So, we’ve gone from the supply of rental accommodation exceeding demand, back to stronger demand. Rents that were low or even falling are going back up.

As an economist would say, with the pandemic over, the rental market is returning to a new “equilibrium” – a fancy word for balance between supply and demand.

What we’re seeing is not so much a “crisis” as a catch-up. One reason it’s happening so fast is the higher interest rates many landlords are paying. But another reason renters are finding it so hard to cope with is that other consumer prices have risen a lot faster than their disposable incomes have.

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Monday, July 24, 2023

Beating inflation shouldn't just be left to higher interest rates

Everyone’s heard the surprising news that last financial year’s budget is now expected to run a surplus of about $20 billion, but few have realised the wider implications. They strengthen the case for relying less on interest rates to fight inflation.

But first, the news is a reminder of just how bad economists are at forecasting what will happen to the economy – even in not much more than a year’s time. Which shows that economists don’t know nearly as much about how the economy works as they like to imagine – and like us to believe.

Then-treasurer Josh Frydenberg’s budget in March last year forecast a budget deficit in 2022-23 of $78 billion. By Jim Chalmers’ second go at the budget last October, that became a deficit of about $37 billion.

By the following budget, in May, the best guess had turned into a surplus of $4 billion. And just two months later – and that financial year actually over – the best guess is now a surplus of about $20 billion.

That’s a forecasting turnaround, over the course of only about 15 months, of almost $100 billion, or 4 per cent of gross domestic product.

What did Treasury get so wrong? It grossly underestimated the growth in tax collections. This was partly because it assumed a fall in the prices of our key commodity exports that didn’t happen, thus causing the company tax paid by our miners to be higher than expected.

But mainly because collections of income tax were much higher than expected. The economy grew at close to full capacity, so more people found jobs and many part-time workers got more hours or became full-time.

A huge number of new jobs have been created, almost all of them full-time. Do you realise that a higher proportion of people aged over 15 have paid employment than ever before? The rate of unemployment fell to its lowest in 50 years and many people who’d been unable to find a job for many months finally succeeded.

Obviously, when people find work, they start paying income tax, and stop needing to be paid unemployment benefits. So full employment is excellent news for the budget.

But the rapid rise in the cost of living during the year caused workers to demand and receive higher pay rises, even though those rises generally fell well short of the rise in prices.

So all the people who already had jobs paid more tax, too. But not only that. Our “progressive” income tax scale – where successive slices of your income are taxed at progressively higher rates – means that pay rises are taxed at a higher rate than you paid on your existing income.

Ordinary mortals call this “bracket creep”. Economists call it “fiscal drag”. Either way, the higher rate of tax workers paid on their pay rises also made a bigger-than-expected contribution to income tax collections and the budget balance.

Note that this unexpected move from deficit to surplus in the financial year just past, this underestimation of the strength of tax collections, has implications not only for the size of the government’s debt at June 2023, it has implications for the size of tax collections in the next few years, as well as for the amount of interest we’ll have to pay on that debt this year and every year until it’s repaid (which it won’t be).

In Frydenberg’s budget in March last year, the projected cumulative deficit for the five financial years to June 2026 was just over $300 billion. By the budget in May, this had dropped to $115 billion.

And now that we know last year’s surplus will be about $20 billion, the revised total projected underlying addition to government debt should be well under $100 billion.

Get it? Compared with what we thought less than 16 months ago, the feds’ debt prospects aren’t nearly as bad as we feared. And the size of our “structural” deficit – the size of the deficit that remains after you’ve allowed for the ups and downs of the business cycle – isn’t nearly as big, either.

Which suggests it’s time we had another think about our decision in the late 1970s – along with all the other rich economies – to shift the primary responsibility for managing the macroeconomy from the budget (“fiscal policy”) to the central bank and its interest rates (“monetary policy”).

One of the arguments used by the advocates of this shift was that fiscal policy was no longer effective in stimulating the economy. But our remarkably strong growth since the end of the pandemic lockdowns shows how amazingly effective fiscal policy is.

It’s now clear that fiscal “multipliers” – the extent to which an extra $1 of deficit spending adds to the growth in real GDP – are much higher than we believed them to be.

We know that a big part of the recent leap in prices was caused by shocks to the supply (production) side of the economy arising from the pandemic and the Russia-Ukraine war. But central banks have argued that a second cause was excessive demand (spending), which happened because the stimulus applied to cushion the effect of lockdowns proved far more than needed.

If so, most of that stimulus came from fiscal policy. Our official interest rate was already down to 0.75 per cent before the pandemic began. So, further proof of how powerful fiscal stimulus still is.

But another implication of the $20 billion surplus is that the stimulus wasn’t as great – and its ultimate cost to the budget wasn’t as great – as we initially believed it would be.

In the budget of October 2020, the expected deficit of $214 billion in 2020-21 was overestimated by $80 billion. In the budget of May 2021, the expected deficit of $107 billion in 2021-22 was overestimated by $75 billion. And, as we’ve seen, the deficit for 2022-23 was initially overestimated almost $100 billion.

This says two things: the fiscal stimulus caused the economy to grow much faster than the forecasters expected, even though the ultimate degree of stimulus – and its cost to the budget – was much less than forecasters expect.

Economists know that the budget contains “automatic stabilisers” that limit the private sector’s fall when the economy turns down, but act as a drag on the private sector when the economy’s booming.

We’ve just been reminded that the budget’s stabilisers are working well and have been working to claw back much of the fiscal stimulus, thereby helping to restrain demand and reduce inflation pressure.

Whenever departing Reserve Bank governor Dr Philip Lowe has been reminded of the many drawbacks of using interest rates to manage the economy, his reply has always been: sorry, it’s the only instrument I’ve got.

True. But it’s not the only instrument the government has got. It should break the central bank’s monopoly on macro management and make more use of fiscal policy.

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Friday, July 21, 2023

Covid spending makes bread and circuses too costly for Andrews

These days it’s not unusual for cities to realise they prefer not to host major sporting events such as the Commonwealth Games and Olympic Games. What is unusual is that it’s taken so long for Premier Daniel Andrews to pull the plug.

The later the decision, the greater the disappointment and the ire of organisers, athletes and sport fans. And, no doubt, the greater the wasted spending.

Even so, it does take great political courage – and maybe overconfidence – to make such a decision, especially based on an undocumented claim of such a massive cost overrun – from $2.6 billion to as much as $7 billion.

If there isn’t a political price to be paid at the next Victorian election, it really will prove Andrews’ invincibility – with able assistance from a hopelessly divided opposition.

It isn’t hard to believe that the now-expected cost is far higher than the initial estimate. But the latest estimate of up to $7 billion does stretch credulity.

Overruns are a virtual inevitability in games hosting. This is shown by a table of overruns for the summer and winter Olympics, prepared by researchers at Oxford University.

It shows that Sydney’s stated overrun of 90 per cent in 2000 was on the high side, but nothing to compare with Atlanta in 1996, Barcelona in 1992 and the all-time winner, Montreal in 1976.

Even so, the table does suggest that the size of overruns has fallen in recent times as, presumably, host cities wise up. Perhaps now it’s cities with more experience – and good existing sporting facilities – that are more likely to seek and win the games, or perhaps these days cities know to take more care with their budgeting.

Initially understating the likely cost seems standard political practice for all public projects, let alone major sports events. “It’ll be great fun, bring us the international recognition we deserve, not to mention huge tourist dollars – and it won’t cost all that much.”

But it’s not just the pollies who mislead us. We’re all so keen to enjoy the games at home that we’re easily convinced they won’t cost much and will bring great benefits.

What gives hosting international games such a great risk of blowouts is partly the international sporting body’s demand for many new venues, but mainly the need for them to be completed by a specific, immovable date.

This leaves the games organisers hostage to greedy unions and private contractors.

But there’s rarely a shortage of “independent” consultants willing to take a highly optimistic view of what it all will cost, and what the (always greater) monetary benefits the games will bring in. Even to the extent of putting a dollar value on the supposed “social” benefits they will bring.

It’s all too easy to overestimate the benefit that all the spending by sport fans – local and visiting – will bring. Economists have put much thought into what they call “the economics of special events”, remembering, as most people don’t, to allow for the greatest insight of economics, “opportunity cost” – what your decision to do X means you now won’t be able to do.

Another pertinent concept is “intertemporal substitution” – decisions to move spending between time periods. Remember, too, that the amount of benefit varies with the perspective from which you view it.

Holding the Commonwealth Games in Melbourne, for instance, would attract many visitors from other states, spending on tickets, travel, accommodation, meals and so forth.

From the perspective of the Victorian economy, that’s a benefit. From the perspective of the Australian economy, however, the extra spending in Victoria is cancelled out by the reduced spending in other states.

From a national perspective, the only benefit is from overseas visitors, spending money in Oz that they otherwise wouldn’t have.

Most of the spending would come from Victorians themselves. But it’s likely most of this is money they otherwise would have spent in Victoria on other things, at other times in the year. So, little net benefit to the state’s economy, except for spending by overseas and interstate visitors.

It’s a different matter, however, for the mayors of the five regional cities that were planned to share the hosting of the games. Their cities would have benefited greatly from the spending by visitors from the rest of Victoria, other states and overseas.

Andrews’ decision to regionalise the games was intended to be their special feature, a new model for how the games could be run. But this dispersion seems to have added greatly to the games’ cost. Even at $2.6 billion, Victoria would have been spending much more than other state hosts of Commonwealth Games.

Andrews has promised that the regional cities will still get their planned new sporting venues, but it’s hard to see how this squares with his new view that the state has more pressing spending priorities.

So, just why has Andrews cancelled at this embarrassingly late stage?

He hasn’t said so, but it’s obvious. Because he spent so much coping with the pandemic, and the great debt this has left him with. He has no room left for spending on bread and circuses.

It’s now become common for cities to think twice about their plans to host Commonwealth or Olympic games – though not for them to leave it this late.

It’s noteworthy that Melbourne had no rivals in its bid for these games. And that no other Australia state is interested in filling the vacuum.

Why has hosting become less attractive? Because it’s finally dawning on cities that building so many new sporting venues – which will be little used after the games’ fortnight – is a waste of money that could have been spent on far more lasting and useful things.

But I doubt this means the days of these funfairs are numbered. The international controlling bodies will have to trim their demands for new facilities, and rotate the games between a few cities that have maintained adequate existing venues.

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Wednesday, July 19, 2023

Don't let the political duopoly block the little guys

What could be better for democracy than taking the big money out of election campaigns? Both Victoria and NSW have made moves in this direction, but the feds have done nothing. Until now. The Albanese government’s working on plans for reform.

Last month, the parliament’s Joint Standing Committee on Electoral Matters, now chaired by Labor’s Kate Thwaites, tabled an interim report recommending sweeping reforms to the rules on donations to political parties.

Thwaites wrote that the evidence the committee heard allowed it to “develop clear goals for reform to increase transparency in election donations and curb the potentially corrupting influence of big money, to build the public’s trust in electoral and political processes, and to encourage participation in our elections”.

The committee proposes that limits (“caps”) be set on the maximum permissible donation and the maximum spending by election candidates. Caps would also apply to “third parties”, such as big organisations seeking to influence the election outcome.

The maximum donation that could be made without the donor’s identity having to be disclosed should be lowered from the present $15,200 to $1000. And the disclosure would have to be made at the time, not months later after the dust had settled.

The Labor majority report also urged a new system of increased public funding for parties and candidates in the light of the effect these changes might have in discouraging private donations.

The committee didn’t specify how the caps on donations and spending would work but left it for the government to decide.

Wow. Wouldn’t all that be an improvement? What’s not to like?

Well, I can think of a big risk. At present, the two major parties are at loggerheads, with the Coalition committee members issuing a minority report. They’re particularly – and rightly – opposed to Labor’s desire to regulate donations from big business while exempting donations from big unions.

But as I’ve written before – and will keep writing – the big political development of our time is not the continuing struggle between Labor and Liberal, but the continuing decline of the two-party system of government, as the bad behaviour of both sides turns an ever-growing proportion of voters away to the minor parties and independents.

I think it will become rare for one side to have a comfortable majority, and common to have a minority government. If so, whichever side forms government will be more dependent on winning the support of the crossbenchers – which, I hope, will make them more reformist.

My interest in this is not just that it affects the economic policies governments will be pursuing, but that economists have given much thought to the way small numbers of big firms – “oligopoly” – find ways to compete that are better for them and worse for their customers.

One thing economists know is that the two parties of a duopoly commonly settle into a carve-up of the market that makes life cosier for both of them.

Oligopolists collude – tacitly, of course, since overt collusion is illegal – to keep prices and profits high. This leaves them exposed to some new firm entering their market and taking business away from them by undercutting those excessive prices.

So oligopolists devote much attention to finding ways to raise barriers that stop interlopers entering their market. Often, this involves persuading governments to raise those barriers for them. All for the greater safety of the customer, naturally.

Do you see the parallel with the threat the teals pose to the Liberals, and the Greens pose to Labor? Except that, in the two big parties’ case, when they combine to repel intruders, they don’t have to extract a favour from the government because they are the government.

Surely, there’s some hidden solution to neuter those pesky minor parties that the two big guys could cook up?

Well, the teals, in particular, needed huge donations from badly dressed internet billionaires (and lesser mortals) to knock off so many sitting Liberal members. So maybe we can toughen up on donations in a way that wins much approval and looks even-handed without people noticing it’s disadvantaged the interlopers more than us.

If we have fewer funds from donations, but more public funding, that advantages the established parties because, although every candidate gets the same dollars per vote, the funding you have to spend in this election campaign was determined by how many votes you got last time.

Oh, you didn’t run last time? What a pity.

But that benefit is small compared with the advantages of being the incumbent. Sitting MPs and senators get better paid than most of us, but they also get electoral staff, cars, travel allowances, printing allowances and much else.

All this support is justified as helping the pollie give their constituents good service. But it’s easily diverted to helping them get re-elected. When pollies shake many hands at a school fĂȘte, are they just doing their job, or shoring up their vote? Both.

When the government comes up with its plans to reform election donations and spending, we’ll need to examine their implications carefully.

Read more >>

Monday, July 17, 2023

Bullock the safe choice as RBA governor, but is that what we need?

In Treasurer Jim Chalmers’ decision to accept the internal candidate as successor to Philip Lowe as Reserve Bank governor, we see what may become the ultimate judgment about the Albanese government: it wanted change, but not radical change. Not change that rocked the boat too much. Certainly, not change that got big business offside.

The choice of deputy governor Michele Bullock to move up one chair will delight the Reserve’s higher ranks (though the put-upon lower ranks may have been hoping for a newer new broom to sweep out the old order).

As with most institutions, the Reserve’s insiders want the internally determined pecking order to be preserved. The governor persuades the Canberra politicians to appoint the next-most able person as deputy and, when the time comes, they move up, as do those in the queue behind them.

The Reserve insiders’ great fear is that the pollies will impose one of their trusties on them, or – next worse – that someone from their eternal bureaucratic rival, Treasury, will be appointed to sort them out. Either way, the pecking order is disrupted.

Over the years, the Reserve has had much success in persuading governments to let it choose its own governor. This has been the safe choice for pollies of both colours.

Only once has the internal order been disrupted in (my) living memory, which was when, in 1989, treasurer Paul Keating decided to move his Treasury secretary, Bernie Fraser, from Treasury to the Reserve.

Although I was disapproving at the time, it turned out to be a very healthy development. Fraser brought a breath of fresh air to a fusty institution. He was one of our better governors, a lot more reforming than his predecessors.

Fraser came to fear that one day he’d wake up to find himself reporting to a new Liberal treasurer, Dr John Hewson, a former economics professor, who’d immediately impose on him the latest international fashion, a central bank with operational independence from the elected government, whose decisions on monetary policy (interest rates) would be guided by an inflation target.

That never happened, of course. But Fraser decided that, if this was the way the world was turning, he’d get in first and design his own inflation target, ensuring it was a sensible one.

The Kiwis, who were the first to introduce such a target, set it at zero to 2 per cent, which became the international standard. But, with help from the Reserve’s best people, Fraser decided on something more flexible: to hold the inflation rate between 2 per cent and 3 per cent “on average” over the cycle.

So, it wasn’t just higher than the others. While they had a target with sharp corners, our “on average” would free the Reserve from having to jam on the monetary brakes every time the consumer price index popped its head above 2 per cent.

Foreign officials kept telling the Reserve it should get a proper target like the Kiwis. But in the end, it was they who had to accept their target was too inflexible.

Fraser announced the new target in 1994, by casually dropping it into a speech to business economists. It wasn’t until the next Liberal treasurer, Peter Costello, arrived in 1996, that the target, and the Reserve’s operational independence, were formalised in an agreement between Costello and the new governor, Ian Macfarlane.

Opposition leader Peter Dutton has said that neither present Treasury Secretary Dr Steven Kennedy, nor Finance Secretary Jenny Wilkinson should be appointed to succeed Lowe because they would be “tainted” by their work with the Labor government.

This was ignorant nonsense. He failed to note that both those people were equally “tainted” by their close work with that last Liberal treasurer, Josh Frydenberg, throughout the pandemic.

So it’s worth remembering that, because of Fraser’s close connection to (by then) prime minister Keating, the money market smarties were convinced Fraser wouldn’t be raising interest rates before the 1996 election.

Wrong. He did. Indeed, he raised them before a crucial byelection, which Keating lost in the run-up to losing the election. Since then, governor Glenn Stevens raised rates during the 2007 election campaign, and Lowe during the 2022 campaign.

Getting back to the point, I’d have been happy to see someone from Canberra put in to implement the (more sensible of the) reforms proposed by the recent review of the Reserve’s performance. Such an insular, self-perpetuating institution needs a regular injection of new blood.

With the benefit of hindsight, it’s almost as though Lowe’s speech last week outlining the Reserve’s plans to implement the review’s recommendations – with Bullock having done most of the work on those proposals – constituted her application for the top job.

Or maybe it was the Reserve’s written undertaking to the Treasurer that, should he agree to preserve the order of succession, it would nonetheless faithfully implement the changes needed.

That so many of those changes – which would be of little interest to any but Reserve insiders and the small army of Reserve-watching outsiders – can be described as major reform says much about what a stick-in-the-mud outfit successive governments have allowed it to become.

The number of meetings of the Reserve Bank board will be cut from 11 a year to eight. Really. Wow.

In making that change, the Reserve will continue its practice of having four of its meetings timed to come soon after publication of the quarterly CPI. But it will use the opportunity to have the remaining four meetings come soon after publication of the quarterly national accounts.

The present practice of meeting on the first Tuesday of the month meant it was meeting the day before it found out how fast the economy had been growing.

Get it? The Reserve could have fixed this problem any time in the past several decades by moving its board meetings to fit. But no, it took a full-scale independent review to make it change its practice. We like doing things the way they’ve always been done. (The good news? No more meetings on Melbourne Cup Day.)

The only significant administrative change will be to have decisions about interest rates made by a board better able to argue the toss with the governor. In particular, what they need (and is already in the pipeline) is someone with expertise in real-world wage-fixing.

The real world keeps changing under the feet of economists, and we need central bankers capable of changing their views in an economy where the cause of inflation is changing from excessive wage growth to excessive profit growth.

That requires more debate within the Reserve, and more opportunity for the newly recruited bright young economics graduates to debate matters with the old blokes at the top.

The Reserve’s problem is too much deference to the views and wishes of the governor. It’s long been a one-man band. Bullock’s appointment as the first female governor ends that problem at a stroke. Let’s hope she does better than turn it into a one-woman band.

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Friday, July 14, 2023

Less competition reduces the power of interest rates to cut inflation

The ground has been shifting under the feet of the world’s central bankers, including our own Dr Philip Lowe, the outgoing chief of the RBA. This has weakened the power of higher interest rates to get inflation down.

Like all economists, central bankers believe their theory – their “model” – gives them great understanding of how the economy works and what they have to do to keep inflation low and employment high.

They know, for instance, that inflation – rising prices – occurs when the demand for goods and services exceeds the economy’s ability to supply those goods and services. So they can use an increase in interest rates to discourage businesses and households from spending so much.

This will reduce the demand for goods and services, bringing it into alignment with supply and so stop it causing prices to rise so quickly. It will also slow the rate at which the economy’s growing, of course.

But, with a bit of care, they won’t need to push interest rates so high the economy goes into “recession”, when demand (spending) becomes so weak that the economy gets smaller, causing some businesses to go bust and many workers to lose their jobs.

This theorising has worked reasonably well for many years, leading central bankers to be confident they know how to fix the present surge in inflation.

But the economy keeps changing, particularly as we keep using advances in technology to improve the range of goods and services we produce, and the way we produce them.

One consequence of our businesses’ unending pursuit of labour-saving technology – more of the work being done by machines and less by humans – has not been fewer jobs, but bigger factories and businesses.

As in all the rich economies, many industries are now dominated by just a few huge companies. In our case, we’re down to just four big banks, three big power companies, three big phone companies, two airlines and two supermarket chains. And that’s before you get the handful of giants dominating the rich world’s internet hardware, software and platforms.

Trouble is, when just a few firms dominate an industry, they gain “market power” – the power to hold their prices well above their costs; to increase their “markup”, as economists say.

The size of markups is a measure of the degree of competition in an industry. When competition between firms is strong, markups are low. When competition is weak, markups are high.

There is much empirical evidence that industries in the rich countries have become more concentrated over time, and markups have risen. And, as I’ve written before, Australia’s no exception to this trend.

In economics, “monopoly” means just one seller. “Monopsony” means just one buyer. So, when a firm has a degree of monopoly power, it can overcharge its customers. When a firm has a degree of monopsony power – when workers don’t have many employers to pick from – it can underpay its workers.

Researchers have found much evidence of labour-market power. And again, I’ve written before about the evidence this, too, is happening in Australia.

But this week, at the annual Australian Conference of Economists, federal Competition Minister Andrew Leigh, himself a former economics professor, drew attention to two recent International Monetary Fund research papers suggesting that a lack of competition is reducing the effectiveness of monetary policy – the manipulation of interest rates – in influencing inflation.

The first paper, by Romain Duval and colleagues, uses American data and data from 14 advanced economies to find that, compared with low-markup firms, high-markup firms are less likely to respond to changes in interest rates. The level of their sales changes less, as do their decisions about future investment in production capacity.

So, fat markups mean companies are less likely to change their behaviour. They’re not likely to cut their investment spending, for example.

This means more of the pressure to respond to higher rates will fall on households with big mortgages, but also on firms with low markups.

The second paper, by Anastasia Burya and colleagues, uses online job ads from across the United States to find that in regions where firms have a lot of labour-market power – that is, where workers don’t have much choice of where to work – those firms can hire workers without having to offer higher wages to attract the people they need.

This is the opposite of what standard theory predicts. It’s bad news for workers, who could have expected strong demand for labour to push up wages.

But another way to look at it is that, where big firms have labour-market power, there’s little relationship between employment and the change in wages. If so, conventional calculations of the “non-accelerating-inflation rate of unemployment” – the lowest point to which unemployment can fall without causing wages to take off – will give wrong results, encouraging central banks to keep unemployment higher than it needs to be.

And at times when price inflation is too high, unemployment will have to rise by more than you’d expect to get the rate of inflation back down to where you want it. How do you bring about a bigger rise in unemployment? By increasing interest rates more than you expected you’d have to.

So, whether it’s inadequate competition in the markets for particular products, or inadequate competition in the market for workers’ labour, lack of competition makes monetary policy – moving interest rates – less effective than central bankers have assumed it to be.

The model of how markets work that central bankers (and most other economists) rely on assumes that the competition between firms – including the competition for workers – is intense.

In the real world, however, markets have increasingly become dominated by just a few huge firms, which has given them the power to keep prices higher than they should be, and wages lower than they should be.

Leigh, Minister for Competition, gets the last word: “If you care about central banks being able to do their jobs, then you should care about a competitive and dynamic economy.”

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Wednesday, July 12, 2023

Robodebt: Politicians behaving badly to win our approval

Cliches become cliches because so many people see how aptly they capture a situation. My rarely achieved goal is to initiate them rather than reuse them. But at least let me be the first to see how aptly one applies to the robo-debt scandal, by paraphrasing Thomas Jefferson: we get the politicians we deserve.

You may not know it, but there once was a time when the convention – rigorously policed by Yes, Minister-style bureaucrats – was that incoming governments did not inquire into the doings of their predecessors.

But that convention was breached a long time ago, and now it’s conventional for every newly elected government to immediately initiate formal inquiries into the misdeeds – actual or supposed – of the government the voters have just thrown out.

It’s become another of the many advantages of incumbency. You improve your chances of a prolonged period in power by discrediting your traditional opponent in the eyes of the electors.

The first such inquiry I remember was the Costigan royal commission into the notorious activities of the Ship Painters and Dockers Union, called by Malcolm Fraser’s Coalition government in 1980, in the hope of embarrassing Labor.

The Howard government established another anti-union royal commission, into the building construction industry, and the Abbott government set up royal commissions into the Rudd government’s ill-fated “pink batts” home insulation program, and into trade union governance and corruption, hoping to embarrass the then Labor leader, Bill Shorten. So it may not be a simple coincidence that Shorten was the minister who commissioned the robo-debt inquiry.

I was once a supporter of the no-looking-back convention, but now I see that the decline in standards of political behaviour require governments to be held more strictly to account – if only in retrospect. When you think about it, the old gentlemanly convention – that dog doesn’t eat dog – arose from the two political sides colluding to make their lives easier at the expense of the public’s knowledge of what they’ve been up to.

So, it’s a good thing that this royal commission has shone a bright light on robo-debt as “a crude and cruel mechanism, neither fair nor legal” that made many people on the dole and other benefits “feel like criminals”.

“In essence, people were traumatised on the off-chance they might owe money,” the commissioner concluded.

The Liberal ministers who initiated and had oversight of this horrendous scheme should face the music, and those ministers who allowed it to run on for years despite its iniquities being well known (I wrote about them in early 2017) should be ashamed.

But while we’re all pointing accusatory fingers at the former government, I don’t think the rest of us should get too high on our high horse. Most of us don’t come out of this episode with clean hands.

The truth is, most of us knew – or certainly could have known – what was going on, but weren’t too bothered by it. We didn’t inquire further.

When the opportunity arose to disgrace its political opponents, the Albanese government knew where the bodies had been buried but, at the time, the Labor opposition didn’t make a great fuss about robo-debt.

Media outlets love boasting about the royal commissions their investigations have forced on reluctant governments but, with an honourable exception or two, they can claim little credit for this one. This one’s a win for the #notmydebt victims using social media.

People are right to see the former government as being utterly, shockingly lacking in compassion in its treatment of people falsely accused of owing the government money. For such a measure to be initiated by someone proud to proclaim his Christian faith is truly shocking.

But it’s wrong to see these people just as ruthless debt collectors, determined to cut government spending by fair means or foul. Scott Morrison wanted to be seen as the tough welfare cop.

The government wanted to be seen getting rough and tough with dole bludgers because it knew many voters would find it gratifying.

Labor knows it, too. That’s why it wasn’t making much fuss at the time. And why, in the May budget, it rejected expert advice that it greatly increase the rate of the JobSeeker payment to stop it being well below the poverty line.

Both sides of politics know there’s much “downward envy” among Australians. Hard-working, tax-paying people who greatly resent those people – mainly youngsters – who prefer sitting around at home rather than getting out and finding a job, but still have the government giving them money.

There are many reasons I’m proud to be an Australian. But one thing that makes me ashamed is the way our politicians seek popularity by pandering to the worst side of the Australian character: our tendency to scapegoat those less fortunate than ourselves, particularly boat people and the jobless.

Like Joe Hockey, we see ourselves as “lifters”, and greatly despise those we regard as “leaners”.

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Monday, July 3, 2023

CitySwitch Awards Night, December 3, 2012

No one ever promised moving to a green economy - an economy making minimal use of fossil fuels - would be easy, and so it has proved. Indeed, in recent years the challenge has look dauntingly tough. It’s too easy to leave it to other people - and other countries - to make the first move. It’s too easy to make excuses and even to deny there is a problem. Sometimes I think I’m glad I didn’t do much science at high school, so I’m not tempted to think I can explain to the scientists where they’re getting it all wrong.

Even so, I get the feeling we’re making more progress in recent days - and that we’ve been making more progress than popularly believed. Here in Australia, the breakthrough may have come with the introduction of the carbon tax on July 1 which - as many of us prophesied - wasn’t nearly as catastrophic as the public had been led to expect. The tax had been designed to be as least disruptive as possible, and so it has proved. With any luck, this anticlimax will see a turning of the tide in our resolve to get on with preparing for a green future. I read that the carbon tax is now more popular than Tony Abbott - though that’s not setting the bar very high. (46/44; -31 net approval)

In recent days we’ve seen a number of new authoritative reports - mainly from scientific authorities, but also from no more unexpected body than the World Bank - reminding us the climate change problem hasn’t been wished away. It’s still there and, if anything, getting more pressing. That’s hardly good news, but I get the feeling these reports have been getting more media attention than they would have done a year ago.

Another bit of encouraging news is that, soon after his comfortable re-election, President Obama reaffirmed his view that man-made emissions of greenhouse gases are contributing to global warming, and stated his intent to continue to take action to reduce greenhouse gas emissions. He said: “I am a firm believer that climate change is real, that it is impacted by human behaviour and carbon emissions,” noting that, “we have an obligation to future generations to do something about it.”

It’s true the US Senate has declined to agree to an emissions trading scheme, but though that may be the best way to progress the move to a green economy, it’s not the only way. And the Obama Administration has made great strides in instituting stringent new fuel efficiency standards for cars and light trucks. A related approach is greenhouse gas regulations issued by the US Environmental Protection Agency, which would limit emissions from certain power plants. And we shouldn’t forget that California and several other states are proceeding with trading schemes.

Similarly, many people don’t realise how much progress China is making in the development of renewable energy sources such as wind and, particularly, solar. When Julia Gillard’s recent white paper on the Asian century included projections for the growth in Chinese demand for our coal, Professor Ross Garnaut expressed the view that these seemed far too high because they underestimated the extent to which China would be relying on green energy sources.

And then, of course, there’s the little publicised fact that the Chinese government is proceeding with an emissions trading scheme on a trial basis in various provinces. Knowing the Chinese way of doing things, I won’t be surprised to see this develop into a nation-wide scheme.

The final bit of good news is the way so many of our own businesses are seizing the challenge and the opportunity to become front-runners in the shift to a green economy. This is occurring in various areas of business, but - as we’ve heard - in none more successfully than in the CitySwitch program. It’s great to see building managers and tenants combining with city councils to use energy more efficiently. They say there are no free lunches in the economy, and it’s true many lunches that look free aren’t really, but there are some, and when you can combine doing the right thing by the planet - and by our grandchildren - with saving on energy costs, this surely qualifies. If doing the right thing and saving on costs also brings competitive advantages - including by making more conscientious employees keener to work for such an enlightened employer - then all I can say is: you deserve it. I’m pleased to be here tonight to honour all the participants in the CitySwitch program as well as those receiving awards.
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Economics and wellbeing: beyond GPD

Economic Society, Sydney, Tuesday, December 11, 2012

We had been hoping to have a speaker willing to argue that GDP was good enough to guide our policy decisions without need for modification or supplementation, but he’s unable to attend - which is a pity because I would have been interested to hear his arguments. In the absence of someone in the audience willing to argue that position, I think there’s a lot we can agree on. Where we’re likely to differ is in our degree of enthusiasm for the beyond-GDP project and how exactly we should go about developing a supplementary measure or range of measures.

Starting with the ‘agreed facts’, as the lawyers say, I doubt there are many if any economists who need to be lectured by greenies or lefties on the various reasons why GDP is an inappropriate measure of wellbeing or social progress. We all know about defensive expenditures and so forth. Further, we all know GDP was never intended or designed to be such a measure.

And I think all of us here tonight can agree that GDP is a reasonable measure of what it was designed to measure - production and income - and that the continued calculation of GDP is vitally important as an aid to the management of the macro economy. So no one here wants to abolish GDP.

It’s worth noting, however, that the 2009 report of President Sarkozy’s Commission on Economic Performance and Social Progress - the Stiglitz, Sen, Fitoussi report - did offer some significant criticisms of GDP just from a quite conventional, narrow, material wellbeing perspective. It noted that GDP had given Americans in particular an exaggerated impression of how well they were doing in the years leading up to the GFC, with company profits overstated because they were based on asset values inflated by a bubble and with a lot of the growth built on consumers and governments spending money they’d borrowed rather than earnt. It argued that in measuring material wellbeing, the focus should be shifted from production (GDP) to real household income and consumption, since household income can grow at a different rate to GDP. It further argued that income and consumption should be judged in conjunction with households’ net wealth, and that focusing on median income rather than average income is a better, easy way to take at least some account of the distribution of income.

A lot of the report’s criticisms can be met merely by switching from GDP to another aggregate published each quarter in the national accounts (but given almost no attention): real net national disposable income - ‘rinndi’. This measure switches from production to disposable income, takes account of the depreciation of manmade capital, the effect of movements in our terms of trade and the truth that, particularly for an economy with a huge net income deficit like ours, national product is a more appropriate measure than domestic product.

As you may know, I’ve been banging on about the limitations of GDP, and the need for it to be supplemented by a better, broader measure of wellbeing for some time. I was greatly reinforced in this view by the report of such luminaries as Stiglitz and Sen. For more than a year now, Fairfax Media has commissioned Nicholas Gruen to prepare such a broader measure, the Herald-Age Lateral Economics wellbeing index, for publication a few days after the quarterly national accounts.

The HALE index starts by turning GDP into real net national disposable income - rinndi - but then it adds adjustments for as many wider aspects of wellbeing as Nicholas could find decent measures of: the value of the net depletion of natural resources (after allowing for new discoveries), the estimated cost of future climate change, the gain in human capital from all levels of education and training, changes in income inequality, the gain or loss from various measures of the nation’s health and the state of employment-related satisfaction.

If you’re interested in getting your teeth into what a beyond-GDP measure of wellbeing might look like, we’re happy to explain and defend the HALE index. I asked Nicholas to come up from Melbourne tonight for that purpose. We don’t make any claim the index is a complete measure of every dimension of wellbeing, we don’t claim there’s nothing about its methodology that’s open to debate, but we do claim it’s an honest attempt to measure broader wellbeing - welfare, if you like - not some lefty attempt to think of as many negatives as possible to subtract from GDP.

The most obviously debatable part of the methodology is the decision to produce a single, modified-GDP figure for wellbeing. We know Stiglitz and Sen opted for the ‘dashboard’ approach - produce a range of relevant indicators of the various dimensions of wellbeing - rather than a single magic number. And we know the Bureau of Statistics, with all the effort it has put into its MAP project - Measures of Australia’s Progress - is also very much in the dashboard, they-can’t-be-added-up camp. So what are the reasons to prefer a single measure and, once you’ve decided to go down that track, how on earth do you add them together?

These are questions Nicholas, as the designer of the index, is far better qualified to respond to than I am. But I do want to say something from a more psychological, behavioural economics, political economy perspective. Why is it so many people have fallen into the habit of treating GDP as though it was a measure of social progress, even though it isn’t? The first part of my explanation is that economists, by their behaviour rather than their conceptual understanding, have led the uninitiated - politicians, business people, the media - into assuming GDP is the only indicator that matters because they get so excited about it so often, and don’t get so excited about anything else.

They say that what gets measured gets managed, and what doesn’t get measured doesn’t get managed, so if you accept there’s more to our wellbeing that just GDP (or even rinndi) that’s the first reason for wanting to publish something to sit beside GDP. In terms of human psychology, part of the reason for the great attention GDP gets is that new figures are published so frequently and that they’re always changing to an interesting extent.

Finally, we know from the findings of neuroscience that, contrary to our assumption of rationality, humans have surprisingly limited mental processing power and can’t weight up more than one or two dimensions of a problem at the same time, which - among many other implications - means humans are irresistibly attracted to bottom lines - to ‘net net’, as they say in the markets. People want a bottom line, will probably pick one by default, and GDP looks likes it is one. Dashboards may be more methodologically pure, but in a world of human frailty and limited attention, they just don’t cut it.
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