ROSS GITTINS

How manufacturing will survive the high dollar

2012-02-27T10:09:00.000+11:00

Beware of dire predictions that manufacturers will be wiped out by the strong dollar unless they're propped up by the government. All our experience says it won't happen.

Manufacturers and their (highly vociferous) unions gave us the same warning in the 1980s when the Hawke-Keating government decided to take away their protection from imports. It didn't happen - the industry adapted, and survived to complain another day.

Though manufacturing's share of the nation's total output (gross domestic product) and total employment has been declining for the best part of 40 years, little of this is due to the removal of protection.

Most is explained by the services sector growing at a faster rate than manufacturing grew. On the employment side, it's also explained by computerisation and other technological advances raising the productivity of labour in manufacturing, so that the same quantity of output could be produced using fewer workers. (Agriculture and mining have the same characteristic, in contrast to the labour-intensive services sector.)

So it's only in recent years that the absolute quantity of Australia's manufacturing production has begun to decline. Manufacturing survived the removal of protection by rationalising its production, becoming leaner and fitter.

And probably by hastening its introduction of the latest labour-saving technology. When employers get their unions to pressure Labor governments to provide protection (or, these days, direct government grants), the workers imagine they're protecting jobs.

In truth, all they can protect is profits. That's certainly the history of what happened in manufacturing during protection's last hurrah in the decade before 1987.

One way manufacturing responded to the removal of protection was by getting into the business of export. That was utterly contrary to the prediction that without protection against imports it would cease to exist.

When vested interests make such claims they're playing on the public's lack of knowledge of economic history, lack of imagination and lack feel for how market forces work.

In a market economy, nothing stays static. Industries could just sit there doing nothing until their last customer leaves, but they don't. They take evasive action. They cut their coat according to their cloth. More formally, they adapt to their changed economic environment.

Individual firms may bite the dust, but the industry regroups and survives. Consider the advent of television from the mid-1950s. Many people imagined it would spell the end of radio.

Instead, radio changed its programming markedly and survived. It went from being something people sat in the living room listening to, to something they carried around with them, particularly in their cars. They listened to it while they were doing something else: driving somewhere or cooking the dinner.

Many people imagined television would spell the end of the cinema. It's true most of the cinemas in every suburb were converted to supermarkets, but then along came the video cassette recorder and video lending shops.

Finally, someone invented the multiplex cinema, a classic example of exploiting economies of scope (producing more than one product at the same plant). Today a wider range of movies would be showing in any city than when suburban cinemas were at their height.

So what can we say about how manufacturers may adapt to a prolonged high exchange rate? Well, one possibility is that they simply move their production abroad to where labour is dirt cheap.

You have to suffer all the illusions and delusions of protectionism and mercantilism to think that would be a terrible thing; that most of the displaced workers wouldn't be able to get work elsewhere in the economy. But, in any case, I doubt if nearly as much of it will happen as is feared.

So what else? People say the high dollar reduces the international competitiveness of our manufacturers. Actually, it reduces their price competitiveness. So one way to respond is to search for ways to reduce their production costs - by becoming yet more capital intensive (raising the productivity of their labour) or finding other efficiency improvements.

Another response is to find non-price ways to stay competitive. A reputation for high quality can justify pricing at a premium. Indeed, if you're smart you can get into the space where the causation is reversed: people take your higher price as a sign of higher quality (utterly contrary to the most basic assumptions of conventional economics).

You can use superior design to justify charging higher prices. You can beat the foreign mass-producers by being more carefully and quickly attuned to changing fashion. Or you can be more willing and adept at customising your product. If all else fails you can get yourself a reputation for giving good after-sales service.

This is an old Australian angle, but still relevant: look for niches to occupy. One advantage of our smallness relative to the rest of the world is that what seems too small to the big boys seems quite big to us.

If manufacturers are to get their cut from the much-foreshadowed blossoming of the Asian middle class, it's pretty safe to be in niche areas that are too small for our bigger rivals to worry about, or that somehow exploit the novelty of our Australianness.

I think this time it is quite likely manufacturing's output will decline. But it's even more likely we'll retain a manufacturing sector that's leaner and fitter than it is today.

If it does survive and prosper it will be because manufacturers and their employees find ways to raise their productivity and respond with a wave of innovation. There's nothing like having your back to the wall to call forth such an uncharacteristic response.

And it's a safe bet those firms that do best in adapting will be those that do best at enlisting the engagement and initiative of their employees.

Jobs aren't lost, just moved

2012-02-25T11:44:00.000+11:00

As the media keep reminding us, the many pressures for change in the structure of our economy are causing some workers to be thrown out of their jobs. But this is unlikely to cause a decline in overall employment. Huh?

The structure of the economy - as represented by the relative sizes of the various industry sectors - is always changing. Normally the rate of change is so slow we don't notice it. At present, however, the pace of change is much quicker than usual.

These pressures are coming from outside Australia. Many are the consequence of the rapid transition of various populous economies from developing to developed. Some of these "emerging" economies are in South America; most are in Asia.

One big consequence of this development is that much of the manufacturing undertaken in the world is moving from the developed to the emerging economies, where labour is more abundant and thus cheaper. This is hitting manufacturing in all the developed economies, not just us. (They're not enjoying it, either.)

Because the emerging economies' immaturity means they're growing a lot faster than the rich economies, another consequence is that most of the growth in the global economy comes from them. That's been true for years; it will be even truer in the coming decade because the North Atlantic economies damaged their prospects so badly with their financial crisis.

A further consequence is that the cycle in the world prices of primary commodities - food and fibre, minerals and energy - is now driven more by the emerging economies than the rich economies.

And the different needs of the emerging economies - for energy, steel and high-protein foodstuffs - have produced a long-lasting change in the structure of world trade, where the demand for primary commodities is growing faster than the demand for manufactures, meaning the prices and volumes of commodities are growing faster than those for manufacturing.

Because the emerging economies have much more economic development to do, and because there's a pipeline of countries coming behind China and India, the increased global demand for commodities relative manufactures is likely to last for many moons.

This is bad news for the real incomes of most of the developed countries (which tend to import most of the primary commodities they use, while gaining most of their export income from manufactures), but great news for us, since our imports are mainly manufactures and our exports mainly commodities.

Of course, both the big advanced economies and we face painful structural change as a consequence of this shift in the structure of the global economy, but I know whose shoes I'd prefer to be in.

In Australia we have to shift resources of labour and capital to the expanding mining (and agricultural) sectors from the declining manufacturing sector and elsewhere in the economy.

The improvement in our trading fortunes relative to the rest of the world is reflected in our higher exchange rate - which is thus likely to stay high for the foreseeable future. To many people, this sounds like terribly bad luck (when they're not thinking about their next overseas holiday, that is).

To economists, however, it's all part of the same deal. Our trading position has improved, so our exchange rate has appreciated to help us bring about the change in the structure of our industries needed to fully exploit that improved position.

In other words, by making it harder for our manufacturers (and tourist operators and education providers) to compete on international markets, the higher dollar is helping shift resources out of manufacturing and into mining and elsewhere.

Of course, the era of the emerging economies isn't the only factor forcing change on our industries. The other big one is the continuing information technology revolution, which is presenting considerable challenges to our established media companies, the book industry, retailers and shopping-centre owners.

I started by asserting that the job losses being caused by structural change were unlikely to lead to a fall in employment overall. Why not? Because what creates jobs is the spending of income.

Starting with the mining boom, it's bringing a lot of additional income to Australia (first from higher prices per tonne, then from a lot more tonnes). But, people object, mining is highly capital intensive so it doesn't employ many people. It may account for 10 per cent of the value of all we produce (gross domestic product), but it accounts for only 2 per cent of total employment.

True, but what happens to all the income the miners earn that isn't paid to their employees? Some of it goes to foreign owners and is spent abroad, but the rest goes to local shareholders and local suppliers to the industry, with Australian governments also getting a big chunk (as they should).

When the local shareholders, suppliers and governments spend that income, jobs are created. Where? At present, a lot are in the construction industry but, more generally, all round the services sector.

How can I be so sure? Because the services sector (including construction) accounts for about 85 per cent of all employment and because it has accounted for all the net jobs growth for the past 40 years.

Next, the advent of new technology often prompts employers to retrench staff as machines replace workers. People imagine these jobs have been "lost", but economists know they've merely been "displaced" (moved).

Why? Because when companies make changes that improve their productivity (output per worker), they raise the economy's real income. The company shares the benefit from its higher productivity among its remaining workers, its shareholders and the taxman, but often competition forces the benefit through to its customers in the form of prices that are lower than they otherwise would be. And lower prices mean higher real incomes.

The point is that as this income is spent around the economy it creates jobs around the economy. Where? Somewhere in the services sector.

Ah, you say, but are all the workers "displaced" from manufacturing able to take up the new jobs in mining or the services sector? A lot more are than you imagine will be able to, but some will have a struggle and some individuals won't make it.

That's why the smart response from governments to pressures for structural change is not to help companies carry on as if nothing in the world had changed, but to help individual workers adjust to that change with help to retrain and relocate.

Yes, there is more to life than happiness

2012-02-22T10:37:00.000+11:00

Fed up with all the wrangling and speculation over who should be leading the Labor Party? Want something more substantial? How about the meaning of life - that weighty enough for you?

The question has been an object of contemplation by clerics and philosophers throughout the ages, of course, but in more recent times many psychologists and even a few economists have taken to studying it.

Psychologists' traditional focus has been on the abnormal - on relieving misery, helping people suffering from depression, alcoholism, schizophrenia, trauma and the like.

But for at least the past 30 years some psychologists and economists have been researching the nature of happiness. A spate of books has been written on the subject (including one by yours truly).

Then, about a decade ago, there sprang up among psychologists a new school known as "positive psychology", dedicated to helping the normal live more satisfying lives. The practitioners of positive psychology seemed to take over the happiness business.

The person most responsible for starting the positive psychology movement is Professor Martin Seligman, of the University of Pennsylvania. Seligman regularly works in Australia, and will speak at the Happiness and its Causes conference in Sydney next week, subtitled Life, Death and Everything. But is happiness all there is to the meaning of life? A lot of people doubt it. The spate of happiness books is now prompting a flow of anti-happiness books - including one by our own (eminently sensible) Hugh Mackay.

I think a lot of the problem lies with the word happiness. It's an eye-catching, emotive word beloved of book publishers and headline writers. But what does it actually mean? Different things to different people.

The critics interpret it very narrowly, as being perpetually in an upbeat, ho-ho-ho mood. And perhaps being a Pollyanna - looking on the bright side of everything and refusing to acknowledge problems.

If that's what happiness means it deserves to be ripped into by the critics. It's neither possible nor desirable to live like Dr Pangloss, and you could do yourself a mischief trying to.

Seligman points out that such an ideal favours those with an extroverted personality, disadvantaging the half of the population who are less expressive and more introverted.

Mackay argues that nature equipped us with the capacity to feel negative emotions - pain, sorrow, fear, even anger - for good reason.

But I've always used happiness to mean something much broader and more substantial. The seeking of pleasure and avoidance of pain is mere hedonism, and that's life without meaning.

Most of the academic study of happiness relies on surveys that ask people to rate their satisfaction with their lives on a scale of, say, one to 10. That's a bit broader, but recent research suggests people's answers to such a question are too greatly influenced by how they were feeling at the time they were asked.

Seligman has been giving the question much thought and the result of his cogitation is outlined in his latest book, Flourish. His objective is to guide the positive psychology movement away from happiness as its goal to something more encompassing, which he dubs "wellbeing".

Wellbeing, he argues, has five elements, of which only the first, "positive emotion", covers the narrow conception of happiness. He calls this "the pleasant life".

His second element is "engagement". Living the engaged life means regularly being in a state of "flow", where you become so absorbed in what you're doing you lose sense of time and consciousness of yourself.

It can involve your work or a hobby, but it requires an equal match between the challenge you face and your ability to meet that challenge. People in a state of flow realise they were happy only in retrospect.

Seligman's third element is "meaning". The meaningful life involves "belonging to and serving something that you believe is bigger than the self," he says. This is where other people first enter the picture.

"Today it is accepted without dissent that connections to other people and relationships are what give meaning and purpose to life," he says.

The fourth element is "accomplishment" - something Seligman added to his list only after a student told him his theory of what humans choose had a huge hole in it: "It omits success and mastery. People try to achieve just for winning's own sake."

Well, that's certainly the way it appears, though a leading economist researcher in this area, Andrew Oswald, of the University of Warwick, would argue that people want to win not for its own sake, but to increase their social status.

Billionaires scrabbling for their next billion aren't motivated by greed. They just want to demonstrate - to themselves and others - how good they are at playing the money game.

Anyway, Seligman now accepts that people pursue success, accomplishment, winning, achievement and mastery for their own sakes. He stresses, however, that his objective is to describe what people actually do to get wellbeing.

"Adding this element in no way endorses the achieving life or suggests that you should divert your own path to wellbeing to win more often," he says.

His fifth element is "positive relationships". When another founder of positive psychology was asked to say what it was about in two words or fewer, he replied "other people". Seligman says "other people are the best antidote to the downs of life and the single most reliable up".

No doubt, but that sounds a bit self-centred. For relationships to be "positive" they have to be two-way; you have to give as well as get. Whatever you call it - happiness, wellbeing, flourishing - it won't work if it doesn't have relationships at its core.

That's what we keep forgetting.

High dollar’s job losses will raise productivity

2012-02-20T08:48:00.000+11:00

If your goal is to raise Australians' material standard of living, the debate about what must be done to increase our flagging productivity is vitally important. But if we want the debate to achieve something, we should stop talking so much weak-headed nonsense.

People are talking about productivity as if it's motherhood for businessmen - all fluffy and soft. Sorry, productivity is more nasty than nice. Sometimes it's red in tooth and claw. It always involves effort and unsettling change, and often involves people being thrown out of their jobs.

As the headlines scream at us every day, many of our industries are being put through the wringer at present, and are shedding workers to prove it. This is not a downturn in the economy, it's the economy being hit by multiple pressures for structural change.

Manufacturers (and tourism and education - not that anyone cares about them) are being hit by the high dollar. Retailers are being hit by the end of a 30-year period in which consumer spending grew faster than household income and by globalisation as the internet breaks down longstanding national price-discrimination schemes. Shopping-centre owners are also in the gun.

Banks are still adjusting to the continuing global financial crisis, which has increased their cost of funds while also increasing their pricing power. Newspaper and media companies, and book publishers and sellers, are adjusting to the information and communication revolution. Qantas is adjusting to deregulation and globalisation.

Guess what? All these nasties are in the process of increasing Australia's productivity - as we speak. To the extent firms are shedding labour faster than their unit sales are declining, they're increasing their productivity as a matter of simple arithmetic.

More fundamentally, structural change is presenting all these firms (bar the banks) with an ultimatum: shape up or die. As they fight for corporate survival in a radically changed world, they will become leaner and fitter. In the process, they'll almost certainly contribute to an increase in national productivity.

What this means, however, is that all the business people, union leaders, opposition politicians and commentators pressuring the government to protect industries from change are fighting to prevent productivity improving. And every time the government gives in to those pressures it's acting to stop productivity improving.

I'm convinced many of the worthies banging on about productivity don't actually know what it is. Productivity is output per unit of input. That means it's about comparing quantities, not prices or values.

This is why productivity and profit (or profitability - profit relative to the equity capital or assets employed to earn the profit) are quite different concepts, not pretty much the same thing - as many business people seem to imagine.

Usually productivity is measured as output divided by units of labour inputs (hours worked), giving the productivity of labour. If you divide output by units of both labour and capital inputs you get "multi-factor [of production] productivity" (which always grows at a much slower rate).

The great delusion of the productivity debate - one inadvertently fostered by crusading economists - is that productivity improvement is a gift governments deliver to business, provided they have the political courage to implement "reform".

Rubbish. As our great private-sector productivity expert Saul Eslake has said: "Productivity only happens as a result of the decisions that are made and implemented in places of work."

So there's an obvious question no one is asking: why have Australia's chief executives failed to increase their firms' productivity for the past decade? Obvious answer: because it's been easier for them to increase their profits without doing much to increase their productivity. (And a big part of the reason for this is that the economy's been growing reasonably strongly, year after year, for 20 years - with just a mini-recession in 2008-09.)

Research suggests few firms actually measure their labour productivity. That's no surprise: the goal of firms isn't to increase their productivity it's to increase their profit - which is what they do measure, carefully and often.

Increased national productivity may be the key to rising material living standards, but increased productivity is just an incidental by-product of a firm's efforts to increase its profit. There are often many easier ways to increase profit than to improve your productivity.

Sometimes firms increase their productivity in response to opportunities or incentives - carrots - created by governments. This is what chief executives dream about while primitive tribes dream about planes dropping cargo from the sky.

Sometimes firms increase their productivity in response to governments beating them with sticks to force them to lift their game. This is known as "micro-economic reform". You slash protection against imports, allow the dollar to float, dismantle a host of interventions designed to give industries an easy life and tighten up the Trade Practices Act.

All this increases the competitive pressure on firms - from imports and local competitors - forcing them to lift their performance and their productivity. Is this the "reform" the business lobbies are crying out for? I doubt it.

Sometimes national productivity is improved by nothing more than firms doing what they do: striving to increase their profits. But, as we've seen, that hasn't been happening for a decade.

Alternatively, national productivity is improved as a by-product of firms grappling with adverse changes in their economic environment that threaten their profits and even their survival.

That's what's happening in our economy right now. You want higher productivity? Your wish is about to come true. When we've got through the present bout of structural adjustment we'll have a much more efficient set of industries. But everyone seems to be hating it.

Herd behaviour, fashion and status seeking

2012-02-18T06:57:00.000+11:00

Think for more than a moment about the causes of the global financial crisis - the fallout from which is still hurting the US and Europe - and you realise herd behaviour had a lot to do with it.

People paid extraordinarily high prices for houses because they felt they were trailing the Joneses. Brokers sold unsound mortgages because they had to keep up with rival brokers. Funds managers - remunerated according to their relative performance against other managers - traded shares with the same motive.

So, the study of herd behaviour must be a pretty important part of economics, right? Wrong. Between 1970 and the onset of the crisis only nine out of 11,500 articles in three esteemed economic journals discussed herd behaviour. And when they did discuss it they usually viewed it as "informational learning" - learning what I should do from your behaviour. If you hear a fire bell and see people running for the exit, you don't inquire further, you just join them.

Yeah, sure. That explains it. Fortunately, one economist who's taken a great interest in herding is Professor Andrew Oswald, of the University of Warwick, in Britain, and the IZA research institute, in Bonn. Oswald spoke about herd behaviour and keeping up with the Joneses at a conference this week to celebrate the contribution of Professor Ian McDonald, of Melbourne University.

Unlike his peers, Oswald has spent his career crossing the boundaries between economics and the other social sciences. Now he's forging links with the physical sciences and is on the board of editors of the journal Science.

On herding, Oswald took his lead from a seminal zoological paper written in 1971. "Before that article, the standard theory in biology was that herds had some inexplicable communitarian instinct," Oswald says. But the article argued that an animal clusters with others because its relative position is what matters. When you're being threatened by a predator, clustering with others reduces the chance it will pick you as its prey.

What has this to do with humans? Just our preoccupation with our position relative to others. Our desire to be in fashion - to wear what our peers are wearing - is motivated subconsciously by our strong desire to keep up.

And falling back worries us because it involves dropping down the status ladder. So, our often demonstrated desire to do what other people are doing seems to show a deep, though unconscious, concern to defend or advance our status (or rank) relative to others.

Economists have long been suspicious of survey evidence, of asking people what they think about things or why they do things. It's too subjective; how can you be sure they're telling you the truth? This is one of the profession's reservations about the study of happiness (of which Oswald has been a leader among economists).

So, Oswald has been interested in finding more objective ways to measure feelings such as happiness. When I compare your rating of your satisfaction with life with your spouse's or your friend's rating of your satisfaction, do they line up? (Yes, they do.)

He's done a lot of work using the British medical profession's system for rating people's mental health, rather than just asking people how they feel about their lives.

Another approach is to use magnetic resonance imaging (MRI scanning) to see what happens inside people's brains when they have certain feelings or encounter certain ideas.

Yet another approach Oswald is pursuing is the use of "biomarkers": can changes in a person's physiology - their heart rate or blood pressure, say - tell us about what they're thinking and feeling?

Oswald quotes the results of a study by German economists who put pairs of people in adjacent brain scanners and asked them puzzle questions, with money rewards for correct answers. They found that outperforming the other guy had a positive effect on the reward-related parts of the brain. People compare themselves with others and enjoy feeling they're winning.

You reckon that's pretty obvious? Not to an economist. Their standard model assumes away all interpersonal comparison. My likes and dislikes ("preferences") are unaffected by other people's preferences and never change over time.

Raise my income by $10 and my satisfaction ("utility") increases. Raise my income by

$20 and there's a commensurately greater increase in my utility. Raise my income by

$10 while you increase my mate's income by $20 and I won't mind a bit.

Actually, we know from happiness research that relative income (how my income compares with yours) has a big effect on how satisfied people feel with their lives.

Oswald asks whether our satisfaction from social status accelerates or decelerates as we increase in status. That is, does our pursuit of status bring increasing marginal utility or decreasing marginal utility?

This question is still being researched empirically. Oswald quotes the case of top tennis players. The gain in utility from going from being third in the world to second is likely to be much bigger than the gain from going from eighth to seventh.

But increasing marginal utility is probably limited to the very top of the status ladder, with diminishing utility applying to most of us.

We know, for instance, that though people with high incomes are happier than those with low incomes successive increases in income buy progressively smaller and smaller increases in satisfaction with life.

Another thing we know is that the rising average real incomes the developed economies have achieved over the decades haven't led to any increase in average levels of satisfaction.

This raises what Oswald calls a "disturbing possibility". "Maybe modern society is stuck," he says. "Individually, we chase higher income and 'rank', but for society as a whole this cannot be achieved."

Here's another worry: "Herd behaviour is often very natural and individually rational. But it has the potential to be disastrous for the group," he says.

"When rewards depend on your relative position it will routinely be dangerous to question whether the whole group's activity is flawed, and be rational simply to compete hard within the rules that govern success."

In the dotcom bubble a decade ago - where the shares of internet companies that had never made a dollar of profit traded for ever more ridiculous prices - those analysts who said it made no sense got fired.

"In financial markets, people are now routinely rewarded in a way that depends on their relative performance" - whether they're in the top quartile, second quartile or whatever. "That's dangerous," he concludes.

Jobs market isn't nearly as bad as you think

2012-02-15T16:39:00.003+11:00

Economists don't have a good record on forecasting what will happen to the economy, but here's a prediction I make with great confidence: whatever happens, it won't be as bad as you think it is. That applies particularly to the jobs market.

Consider this. One day you pick up a newspaper and on page five you read a small story saying employment grew by 10,000 last month, leaving the rate of unemployment unchanged at 5.2 per cent. A couple of days later, every time you turn on the car radio or look on the internet, then settle down at home to watch the evening news, you're told about the car company that's announced its intention to lay off 350 workers. The next day the big news is that a bank intends to lay off 1000 workers.

Question is, what conclusion do you come to about the state of the jobs market? You wouldn't be human if you didn't think things were in pretty bad shape.

You'd need the steel-trap mind of an economist to say to yourself: "These stories I'm hearing about layoffs here and there are sad news for the individuals involved, but they don't really prove anything. To make a balanced assessment of what's happening in the labour market I need aggregate statistics, not anecdotes - and the last stats I saw said that, overall, employment is growing sufficiently to hold the unemployment rate steady at 5.2 per cent."

The human mind isn't particularly good with statistics. Some people even have trouble pronouncing the word. Figures are too cold and impersonal. We're interested in other people, not numbers. So there's a sense in which we're moved more by a story of 350 people losing their jobs than by one saying 10,000 jobs had gone. Of course, what would really engage us is a story, with pictures, about the plight of just one sacked worker, worried about the mortgage and not at all sure where their next job was coming from.

But there's a distinction between fellow-feeling for someone who's struck hard times and assessing how worried we should be about the state of the world.

Already this year we've heard a lot of stories about people being laid off in manufacturing, retailing and now banking. It's a safe bet we'll be hearing a lot more, and that each announcement will get much attention.

How could this not leave most of us with the impression the economy's going to hell in a foreign-made handcart? Yet this impression will almost certainly be exaggerated, and may well disguise a position where, overall, the economy is holding its own.

One reason we're misled is that we're unduly impressed by very small figures. To put it another way, we don't appreciate just how big the economy is. There are 11,421,300 people in the labour force, either in a job or actively seeking one. So 350 people represent 0.003 per cent of the total.

The point is not that the fate of 350 people is unimportant, but that it makes a minuscule difference to the fate of workers generally. Make it 10,000 people and we're still only up to 0.09 per cent.

Another reason we're unduly impressed by news of people losing jobs is we don't realise how much turnover there is in the labour market. Julia Gillard keeps saying that every year about a million workers change jobs - with about a quarter of them also changing the industry they work in. When I checked that surprisingly large figure with an expert, he said it was too low.

(Gillard emphasises the remarkable degree of change in the economy by adding that, every year, about 300,000 businesses close - and 300,000 new ones start up.)

So every month many thousands of people leave their jobs - voluntarily or involuntarily - and many thousands move into jobs. What's another 350?

By now you may have realised we get told about only the tiniest fraction of all the coming and going. In fact, we get told when a big company announces it's decided to get rid of a block of workers. It makes an announcement because it wants to impress the sharemarket or pressure the government for assistance.

But we don't get told when big companies decide to hire a block of workers or, more usually, to hire people in dribs and drabs. And we're told virtually nothing about the hiring and firing by small business. Get the feeling we're being given a biased impression?

There is, however, another, more fundamental reason we'll be getting a distorted impression of what's happening in the economy this year. We're getting the idea the high dollar is causing the economy to slow down and shed jobs.

In truth, the high dollar and the factors that brought it about aren't destroying jobs so much as shifting jobs from one industry to another. That's painful for the contracting industries - and we're hearing their cries loud and clear - but, predictably, we're not hearing much from the expanding industries.

While jobs are being lost in manufacturing and elsewhere, employment will be growing in mining and the construction industry, pretty obviously, but also in the services sector, including in health, education and training, public administration, the science professions and arts and recreation.

I'll be surprised if, overall, we don't see continuing growth in employment. Whether this growth will be sufficient to cope with the natural growth in the labour force and thus hold unemployment steady, I'm not as sure.

But I do know this: with inflation under control, if the Reserve Bank sees unemployment drifting up it will cut interest rates further to encourage borrowing and spending and thus foster faster growth in employment.

What happens now on interest rates

2012-02-13T10:11:00.000+11:00

Until last week, the financial markets and most business economists thought the Reserve Bank had several rate cuts up its sleeve and would start doling them out this month. The smarter ones don't think that any more.

When the Reserve failed to cut the official interest rate last week, some observers swung to the opposite view of expecting no further cuts for the foreseeable. And with all the fuss about the banks' small "unofficial" increases in mortgage rates, you can bet the punters are now convinced rates are heading back up.

Needless to say, the official rate is unlikely to rise. With luck, it won't need to be cut further. But if the outlook for the economy deteriorates, it will be.

Since the Reserve cares most about the rates households and businesses actually pay, and has no desire to tighten the interest-rate screws, the tiny unofficial increase will be one factor - but only one - favouring another cut in the official rate sooner rather than later.

Why didn't the Reserve cut last week? Because you may have convinced yourself the economy's in trouble, but the Reserve hasn't.

For the markets and business economists to have been so sure the Reserve would cut, it was necessary for them to be convinced of the truth of one or both of two propositions.

First, that the outlook for the world economy is now worse than it was late last year. It's true that, in recent times, the Reserve has judged the state of the rest of the world to be the greatest single threat to the continuing growth of our economy.

But almost all the news we've received from abroad so far this year has been reassuring. Things have calmed down a lot in the euro zone, with the actions of the European Central Bank making people a lot less worried about the European banks than they were, with sovereign bond yields falling back to more sensible levels, with banks able to raise funds with new bond issues, with Greece looking like it may reach a deal with its saviours, and with world sharemarkets looking up.

None of this implies the Europeans don't have a lot more to do, nor that there's little chance of something somewhere suddenly going badly wrong. The continuing risk that things could deteriorate in Europe remains the greatest single reason the Reserve could cut rates again this year.

But you do have to say the improvement in conditions in Europe so far this year makes it easier to believe the Europeans will muddle through.

As for the United States, its economy isn't roaring, but it is doing better than it was, growing fast enough to slowly reduce unemployment. For China, it's slowed a bit, but is still growing strongly.

The second proposition you'd need to believe to have been so confident the Reserve would cut last week is that the domestic economy is clearly slowing.

The tribulations of particular parts of the economy - notably manufacturing and retailing - have generated so many negative headlines I've no doubt many people are convinced the economy's in trouble.

Certainly, the belief the economy is slowing is widely held. But that's what happens when the news is mixed, with the bad bits trumpeted and the good bits played down. Just why the commercial media regard misinforming the public in this way as good for business I'm blowed if I know.

Do they imagine only the Labor government will suffer if they succeed in talking the economy down? Do they think it's like "a Martian ate my baby"? It's just entertainment and no one actually believes them?

The unrecognised truth is, the economy's speeding up a little, not slowing down. That's because we're recovering from the effects of the bad weather this time last year. Abstract from the weather effect and the economy's been travelling at about its medium-term trend annual rate of 3.25 per cent for the past two years or so, and is expected to grow at that rate this year.

With the unemployment rate steady at just 5.2 per cent and underlying inflation in the centre of the target range and expected to stay there for the next two years, you'd have to conclude the economy is right on normal.

In which case, the present level of interest rates - close to their own trend rate - must surely be pretty right. But it's clear from the Reserve's rhetoric that it retains a weak "bias to ease" (cut rates further): "the current [favourable] inflation outlook would, however, provide scope for easier monetary policy should demand conditions weaken materially".

How would such a weakening be manifest? Well, obviously by a deterioration in the world economy. Were Europe to implode, the flow-on to the rest of the world would be considerable - even for us. In this case we know how the Reserve would react: by slashing interest rates in a few big, bold steps.

But the requisite material weakening could also be brought about by a deterioration in essentially domestic factors.

The way the Reserve sees it, the economy is being hit by two powerful but opposing shocks: the expansionary effect of the once-in-a-century mining construction boom and, against that, the contractionary effect of the high exchange rate, which has reduced the international price competitiveness of our export and import-competing industries.

At present, the two conflicting forces are roughly offsetting each other, leaving the economy travelling at its trend rate. Should it become clear the high exchange rate is doing more restricting than the construction boom is doing expanding, which would show itself in slowly but steadily rising unemployment, the Reserve will cut rates further.

How fiscal policy does and doesn't work

2012-02-11T06:27:00.000+11:00

It's remarkable that the politicians of Europe and America are making things much worse for themselves and their people because they've unlearnt the economic lessons of the past 70 years.

Economists spent many years studying what policymakers did wrong in the Great Depression of the 1930s, making it much worse than it needed to be. One well-understood lesson was not to try to get the government budget back into balance too quickly.

This is counter-intuitive to many people. The government's tax revenues have collapsed, its spending has increased, it has a yawning budget deficit and government debt is piling up. Surely it's obviously right to get spending and your income back into line as quickly as you can.

Not if you're a national government. Why not? Because governments are so big that what they do affects the rest of the economy. Remember, governments can borrow more for longer than the richest individual or corporation, since they represent the whole community and have the power to pay their bills by levying taxes.

Economic downturns, recessions or depressions almost always manifest themselves in consumers and businesses cutting their spending. The more they cut, the more people lose their jobs and their businesses and the greater the decline in spending.

In such circumstances, it's not possible for the private sector to lift itself up by its bootstraps. Clearly, the government needs to do something that helps the private sector get back on its feet.

One thing the central bank can do is cut interest rates to encourage borrowing and spending. In normal times this is usually effective, but in really bad times a lot of people are too uncertain about the future to want to borrow and expand, no matter how low rates are. And if interest rates are already very low - as they are in the advanced economies at present - you can't cut them below zero.

The next tool available to help the private sector is "fiscal policy" - the budget. The first way to help is do nothing: when fewer people paying tax and more people on the dole cause the budget deficit to blow out, don't do anything to counter it.

This process happens automatically when the private sector turns down, and the fact that some people are paying out less money to the government while others are getting more money from it means the government is helping to cushion the private sector's fall, stopping it from falling further. Thus economists say budgets contain "automatic stabilisers".

If you try to counter the effect of these stabilisers by cutting spending or increasing taxes, you'll push the private sector down further and, because of that, probably won't succeed in getting the budget closer to balance in any case.

The second way to help is more active: stimulate the private sector by cutting taxes or increasing spending. If you were to do this when the economy was strong, you'd just worsen inflation. But if you do it when the economy is flat on its back, it will probably be effective, particularly if you increase spending rather than cutting taxes (which would allow some people to save their tax cuts).

Once you get the economy growing again, tax collections will improve and people will go off the dole, thus causing the deficit to reduce. This is the automatic stabilisers working the other way. Keep it up and the budget balance will turn to surplus, which you can then use to repay government debt.

See the point? Exercise enough discipline and patience and eventually the budget problem will fix itself.

All this had been well understood by economists and politicians for many years. It was how governments responded to the global financial crisis in 2008. But governments in Britain and the euro zone, and the US Congress, are now doing pretty much the opposite.

Their economies are still quite weak but they want to increase taxes or - more commonly - slash government spending to get their big budget deficits down in a hurry. In consequence of this policy of "austerity", the European economies are heading back into recession and their deficits getting worse.

Why are they doing something so counter-productive? Because their stock of government debt is so unsustainably high. Whereas sensible policy involves running surpluses and reducing debt during the good years, they kept running deficits and piling it up in the noughties.

When the global financial crisis struck in 2008, many had to borrow heavily to rescue their banks and then borrow even more to kick-start their economies. Their debt is now so high the financial markets have started wondering whether they'll be able to repay it.

But the flighty financial markets are an unreliable guide to good policy: though they seemed to approve when governments announced their austerity programs, they started disapproving when they saw those programs were causing economies to weaken.

Of course, when a country's sovereign debt gets so high that markets will soon refuse to lend more to it at any price, it has no choice but austerity. You can renege on your debts, but you can't run a deficit if no one will finance it.

Even if some international institution bails you out, it will punish you for your profligacy by insisting on austerity. Will this make things worse long before it makes them better? Inevitably.

That's the case of Greece. But most of the European countries aren't in those dire straits, so why are they slashing spending?

What they should be doing is promising and laying plans to reduce their spending down the track, as their economies recover and can take it in their stride.

Why don't they? Because, after decades of fiscal indiscipline, they don't have much credibility when making promises to be good tomorrow.

But that doesn't change economic reality: cut when the economy's weak and you make it weaker. The answer is to find ways of making their promises more credible.

As for the Americans, they too have years of fiscal indiscipline and a way-too-high level of debt. But though it suits President Obama's critics to claim the US has a "debt crisis", it doesn't. The world is still so anxious to lend to the US government that the yield (effective interest rate) on its long-term debt is down to 2 per cent.

It has plenty of time to get its budgetary house in order but, at present, a hostile Congress has the budget set up to crunch the US economy next year. These guys have learnt nothing.

Propping up private heath insurance unfair, inefficient

2012-02-08T10:38:00.000+11:00

Despite the untiring efforts of Julia Gillard and Tony Abbott to make themselves seem poles apart in their policies - he/she is hopeless, I'm really good - the ideological gap between the two sides has never been narrower.

If you look carefully, that's true even in one of the few remaining points of ideological difference: the funding of healthcare, particularly private health insurance.

When John Howard resumed leadership of the Liberals in 1995, he abandoned their long-standing opposition to Labor's Medicare (and Medibank before it). But that didn't stop him using a succession of carrots and sticks to get people back into private health insurance.

When Labor returned to power in 2007, it lost no time in seeking to water down those incentives. In its first budget it raised the income thresholds at which middle- and high-income earners became liable for the additional, 1 per cent Medicare levy surcharge if they didn't have private insurance.

In its second budget it sought to means test the 30 per cent health insurance rebate, reducing it for higher-income earners and removing it for those even higher up. Labor seems to have wanted this as part of its efforts to pare back all the middle-class welfare Howard introduced to health and social security payments.

But the measure was knocked back by the Senate, mainly because of the implacable opposition of the Libs. Labor has sent the bill back to the Senate every year since then, only to have it rejected.

This week the newish Minister for Health, Tanya Plibersek, is conducting discussions with the independents and the Greens in the hope of having more success this year. Strangely, if the Greens join forces with the Libs to block the bill one more time, it will be because they profess to believe it doesn't go far enough.

Plibersek has sought to demonstrate the unfairness of the rebate with figures showing that while just 12 per cent of couple taxpayers earn more than $160,000 a year between them, they account for 21 per cent of the couples benefiting from the rebate - worth, typically, about $1000 a year. For single taxpayers, the 14 per cent earning more than $80,000 a year account for 28 per cent of the singles getting the rebate. It's a concession for the well-off.

The health funds and the Liberals oppose the means test because, they claim, it would lead many people to abandon private insurance.

Leaving aside the question of why that would be such a bad thing, this is a weak argument.

Treasury's calculations show that only about 0.3 per cent of the 10 million people with insurance would quit. And it's not hard to see why. Higher earners are essentially compelled to hold private insurance by the Medicare surcharge. And Labor's plan actually involves increasing the size of that stick.

It's clear Labor's motives are to make the system a little less unfair and save the budget a little money (its means test would reduce the $3 billion annual cost of the rebate by about $700 million) without harming private insurance.

So, just as the Libs now accept the legitimacy of Medicare, so Labor now accepts the legitimacy of taxpayer-subsidised and enforced private health insurance. One of the few remaining ideological gaps has greatly narrowed.

The pity is that, as John Menadue and Ian McAuley explain in a new paper published by the Centre for Policy Development, subsidising private health insurance doesn't only advantage the better-off (including yours truly), it makes healthcare more expensive than it needs to be.

Healthcare costs to the community - whether funded by the taxpayer or privately - are already growing rapidly and are set to keep outpacing most other costs, becoming by far the greatest pressure on government budgets.

That makes healthcare the greatest source of pressure for rising taxes. Nothing wrong with that - provided we get value for money. But that's just where private insurance lets us down.

Howard's subsidy of health fund premiums was really a vote-buying election promise and a gift to the well-insured Liberal heartland. He tried to justify it by claiming that getting more people into private insurance would relieve the pressure on public hospitals.

As all the experts predicted at the time, it didn't work. It shifted patients from public to private, but it also shifted doctors from public to private, leaving public queues little changed. It did, however, subsidise the better-off in their efforts to jump the queue.

As anyone who's done high school economics could tell you, the benefit from a government subsidy of the price of something is shared between the buyer and the seller. The health funds have become a lot more profitable than they used to be.

All arrangements that separate the true cost of something from what you appear to pay for it at the counter encourage overconsumption, overservicing and overcharging. That's true of Medicare as well as private insurance.

But unlike private insurance, Medicare has countervailing advantages. Being a single national payer, it has lower administrative costs and, more to the point, greater ability to counter the market power of healthcare providers.

Our many private health funds have little ability - and little incentive - to counter overservicing and overcharging. It's a well established principle in health economics that those countries with the greatest reliance on private insurance to finance healthcare have the most expensive healthcare - without a commensurate improvement in their health. The United States is the classic case.

Using carrots and sticks to prop up private insurance not only subsidises a two-class health system, it delivers its greatest benefit to the incomes of medical specialists. Great idea.

Asia well-placed to withstand global slowdown

2012-02-06T09:14:00.000+11:00

Perhaps it's our natural eurocentricity, but we've been hearing a lot more about recession and the risk of worse in Europe than about the resilience of our own region. Fortunately, the International Monetary Fund set the record straight last week.

At a briefing in Washington, the director of the fund's Asia and Pacific department, Anoop Singh, focused on the counter-weight to the weakness in the North Atlantic economies.

If the euro zone is expected to contract by 0.5 per cent this year and the United States to grow by only 1.8 per cent, how come the world is still expected to grow by a not-so-terrible 3.3 per cent? Mainly because "developing Asia" is forecast to grow by a buoyant 7.3 per cent.

Singh made four main points. First, while growth in Asia has slowed, Asian economies have generally proved resilient to the increased turbulence in global financial markets and are helping to support global growth.

Second, there's certainly a risk of contagion to Asia from any further deterioration in global financial conditions.

But, third, the fund believes that, in the event of further slowdown in the global economy, most economies in Asia have room for "a strong policy response" - that is, room to stimulate their economies to offset the effects from abroad.

And fourth, the recent decline in the current account surpluses of China and many other Asian economies is very welcome. Sustained efforts to continue this decline in the medium term will reduce Asia's exposure to the external risks it's experiencing now, thereby maintaining its support for global growth.

"So, in both the short term and medium term, there are positive factors coming from Asia," Singh said.

On his first point, economic activity in Asia has slowed mainly because the growth in its exports has lost momentum, thanks to weaker growth in regional as well as global trading partners. But robust growth in domestic demand is helping offset this drag from external demand.

In China, the two main components of domestic demand - investment spending and consumption spending - have remained resilient, supported by strong corporate profits and rising household income.

And Asian banks have so far used their strong balance sheets to step in and ensure a continued flow of credit and trade finance in the face of the reduction in lending growth by European banks. As growth has slowed in Asia, inflation pressures have waned. So it's not surprising governments have paused the pace of tightening macro policies, or in some cases reversed it. The fund expects inflation to recede further this year.

The fund expects growth in the overall Asia-Pacific region to remain closed to 6 per cent this year, recovering to 6.5 per cent next year. Within this, emerging Asia will remain the fastest-growing region in the world, led by China and India. In China, growth will remain in the 8 to 8.5 per cent range this year, returning close to 9 per cent next year. In India, growth will stay about 7 per cent.

On his second point, these are just the fund's central forecasts. There's a clear risk an escalation of Europe's debt crisis could cause global growth to be 2 percentage points lower than the central forecast of 3.3 per cent.

Were this to happen, Asia would be greatly affected because the usual effect on its exports would be compounded by an adverse effect on business and consumer confidence, as well as by contagion in the financial sector. So there would be a knock-on effect from external demand to domestic demand.

Moving to his third point, were such a deterioration to occur, policy responses by Asia would be needed, without which the impact on Asia's growth would be substantial. But the fund believes many countries have the room to respond.

For many, the room is greater on the fiscal (budgetary) side than the monetary (interest rate) side. The pace at which countries are reducing their budget deficits could certainly be slowed, particularly in those with low levels of public debt, such as China. More than that, some countries could undertake another round of fiscal stimulus.

"Indeed, many Asian countries could advance their plans, which they already have over the medium term, to boost social safety nets and increase consumption and investment," Singh said.

These policies would have long-term positive effects on "rebalancing" - increasing domestic demand and thus reducing reliance on external demand - and growth, as well as reducing income inequality, which remains an issue in many Asian countries.

As for monetary policy, monetary tightening has appropriately been paused in many Asian economies, with some beginning to reverse this tightening. But the room for further easing is limited in economies where underlying inflation pressures remain, such as India. China has little room because it's still absorbing the stimulus from its previous credit expansion of the past two years.

As usual on these occasions, Australia hardly rated a mention. Except for this: "The authorities have certainly committed to return to [budget] surplus by 2012-13, and we have supported that. The authorities have believed that an exit from fiscal deficits is needed to rebuild fiscal buffers and support monetary policy," Singh said.

"Having said that, it is also the case that were downside risks to materialise, with a further slowing of the global economy, in Australia the authorities probably have more policy flexibility than almost any other advanced economy.

"Why? It currently has probably one of the highest policy interest rates, and it probably has the lowest net public debt-to-GDP ratio.

"So, clearly, Australia has the ability to take actions if there were to be a further external deterioration."

Why economic modelling is so tricky

2012-02-04T08:08:00.000+11:00

When I was studying economics at university in the mid-1960s, I wasn't quite sure what a "model" was. These days, politicians and business people are always using the word, and most of us think we know what they mean.

In case you're not sure, here's an explanation I would love to have seen at uni, provided by Dr Richard Denniss, executive director of the Australia Institute, in his new paper, The Use and Abuse of Economic Modelling.

"A model, be it a model car or an economic model, is a simplified representation of a more complex mechanism. A model is typically smaller, simpler and easier to build than a full-scale replica. A model sheds light on the main features of the reality it seeks to represent," Denniss writes.

"An economic 'model' is not a physical thing, like a model car. Rather, it is a mathematical representation of the linkages between selected elements of the economy."

Thus an economic model is, unavoidably, a simplified version of the economy, or an aspect of the economy. It includes those aspects of reality the model-builder regards as most important in explaining what happens, and leaves out all those aspects that don't seem to make a big difference.

So the results you get from a model are only as good as the modeller's choice of what to include and what to leave out. In practice, the model's predictions will often prove astray because some factor the modeller assumed wouldn't be important turned out to be.

Different types of economic models are used for different purposes. Earlier this week I used Denniss's paper to discuss the input-output model that industry lobbies use to make their industry sound bigger than it is.

Today let's discuss the most sophisticated models economists have developed; "computable general equilibrium" models. These are often used to shed light on the effect of a major policy change on the economy over the next 10 or 20 years.

Economists often analyse only a part of the economy, called a "partial equilibrium analysis", while assuming ceteris paribus (all other things remain equal) in the rest of the economy. This is unrealistic because, in the economy, everything is connected to everything else. Changes in one bit lead to changes in other bits, which then feed back on the first bit. So general equilibrium models attempt to capture all these interactions between different industries and markets. (In practice they can't capture all of them, so they still rely on the ceteris paribus assumption to cover those they leave out.)

If you remember nothing else about models, remember this: their weakness is they are built on a host of assumptions, and therefore are only as good as the assumptions on which they are built. Some assumptions are obviously unrealistic and couldn't possibly hold; some happen to be overtaken by events.

Models are sets of equations with dependent and independent variables. The modeller decides the values of the independent (or "exogenous") variables and the model calculates the values of the dependent ("endogenous") variables. So, if the modeller puts in the wrong independent variables (usually assumptions or guesses about the future), the dependent variables will be wrong, too.

The model-builder also specifies the "elasticity" (sensitivity) of the relationships between the variables. For instance, when the exchange rate rises will the reduction in exports be big or small? Elasticities are partly based on empirical evidence, but they also reflect the model-builder's beliefs about how the economy works. Should that belief be wrong, the model's results will be wrong.

It's common for general equilibrium models to be Keynesian in the short run (up to 10 years) but neoclassical in the long run (20 years or more). That is, key variables such as inflation, unemployment and economic growth are determined by the strength of aggregate (total) demand in the short run, but by the strength of aggregate supply in the long run.

This means the economy is assumed to be at full employment in the long run, and economic growth over the period is assumed to be determined solely by the growth in the labour force (the population of working age and its rate of participation in the labour force) plus the rate of improvement in the productivity of labour.

How do you know what the average rates of growth in population and productivity will be over the next 20 years? You take an educated guess, then plug them in. But here's the trick: once you've done that, you've predetermined where the model's results will end up, regardless of whatever policy changes you simulate happening to the economy in the meantime.

No matter how much some change knocks the economy off its assumed long-run course, the model's specifications assume it will not only get back on course but also catch up to where it would have been.

The economy can take up to 10 years to return to its "steady state".

So, the bigger the initial departure from the long-run trend, the bigger the ultimate bounce back - by design. And, by design, nothing can ever happen that changes our destiny.

Thus the model assumes away "path dependency" - the idea that where we end up is determined by what happens to us on the way; that some developments leave us permanently better off, while some leave us permanently worse off. This is clearly unrealistic.

But see what it means? It means the policy change you're purporting to be testing doesn't stand a chance of making much lasting difference, for good or ill. And that means your test is a sham. You give the appearance of testing some proposition, but the outcome is essentially predetermined.

I think such models should be used only in private by consenting economists. They have a good understanding of the assumptions on which the model's results are built and they know whether they share the modeller's faith that the economy works the way her model assumes it does.

When the results of these models are paraded before the public - by governments and treasuries, as well as interest groups - they can't help but mislead. They appear to be proving some policy change would be good or bad but, in truth, they're coming to predetermined conclusions.

The sign that the sponsors and modellers are out to mislead is shown by their failure to highlight their model's key assumptions in some sort of comprehensible product disclosure statement.

Damned lies and economic modelling

2012-02-01T11:49:00.000+11:00

One of my resolutions this year is to spend more time trying to prevent lobby groups from using dodgy economic "modelling" to mislead my readers. Canberra has developed a bad case of modelling mania, but most of it is dubious. The less you know about modelling, the more it impresses you.

Any day of the week you can hear politicians demanding to see the modelling behind some figure the government has produced (even if Treasury did a quick calculation on the back of an envelope).

But the worst offenders are business interests, which pay big money to Canberra economic consultants to produce supposedly independent reports aimed at persuading governments to give them something, or at persuading the public to stop the government taking something from them.

One trick they often pull is trying to make their industry sound bigger and better for the economy than it is. Just last week the Minister for Manufacturing, Kim Carr, was defending the government's grants to the car industry by claiming it provides employment to 46,000 workers and "more than 200,000 in associated jobs".

But the industry that's been trying hardest to bolster its economic importance lately is mining. According to a press release issued by the Australian Mines and Metals Association, "213,200 people are directly employed in mining, oil and gas operations in Australia, with an additional 639,600 indirect jobs created by the resource industry".

Did you notice how the second of those suspiciously precise figures was precisely three times the first? "Spurious accuracy" is one of the signs a con job is in progress.

I'm sure you've seen the ads sponsored by the Minerals Council of Australia and others telling "Our Story" about what a wonderful, caring industry it is. The related website says that "across the nation, mining employs 187,400 people directly, and a further 599,680 in support industries". So for every mining job, another 3.2 are created elsewhere.

According to a report funded by Peabody Energy, "the Australian coal industry employs over 32,000 people and indirectly creates an additional 126,000 jobs in Queensland and New South Wales". So that's an employment "multiplier" of 3.9.

Where do these figures come from? Knowing how many people are employed in a particular industry isn't hard. Every month the Bureau of Statistics conducts a giant sample survey of households, asking them about their experience in the labour market. That's where our monthly figures for employment and unemployment come from. Every third month the bureau asks people what industry they work for.

It's obvious that all industries buy materials and other "inputs" from other industries, to which they then apply a lot of labour and equipment to produce whatever goods or services are their "output". So every industry can justly claim its purchases from other industries create jobs in those industries. Many could claim to create more jobs indirectly than directly.

But how do they know how many? They pay an economic consultant to do a report that tells them. How do the consultants know? They look up the industry's multiplier in a model-based document produced by the bureau called the input-output tables.

Trouble is, the tables are subject to significant limitations, which make it easy for them to be misused. All is explained in a paper by Dr Richard Denniss, of the Australia Institute, to be released today, The Use and Abuse of Economic Modelling in Australia: Users' Guide to Tricks of the Trade.

Like all models, the bureau's input-output model is built on a host of assumptions, as the bureau acknowledges in its accompanying documents. This reliance on assumptions shouldn't surprise you. Were you to work out a household budget for the year, you'd have to make many assumptions, including about what will happen to prices in the future.

Denniss reminds us of the key assumptions: that the relationships between inputs and outputs are fixed and so unaffected by changes in technology or changes in the relative prices of inputs; that all the output of an industry is identical, with no differences in quality or features; and that increasing the quantity of the industry's output would yield no economies of scale.

These unrealistic - but unavoidable - assumptions greatly limit the use you can make of employment multipliers without misleading yourself or others. You can't assume that doubling the size of an industry (such as mining) would also double the number of jobs it created directly and indirectly. Nor can you assume that a significant reduction in the size of an industry (such as car making) would mean the same reduction in total employment.

Another problem is that the employment multipliers involve double counting - more than one industry taking the credit for "creating" a job in some other industry. Denniss finds that if you used the multipliers to calculate the jobs directly and indirectly created by each Australian industry, then added them up, the total would be 187 per cent of all the jobs in the nation.

Yet another problem is the implication that the significant expansion of an industry would do nothing but add to employment in the industry and elsewhere. This assumes such an expansion would have no effect on wage rates, skill shortages, the exchange rate and much else.

Denniss quotes the results of some quite different modelling commissioned by the proponents of what would be one of the world's largest mines, the China First mine in Queensland. It found that, though the mine would lead to 6000 new jobs, it would also lead to the loss of about 3000 jobs, most of them in manufacturing.

We should be highly sceptical about claims made by interest groups on the basis of reports

from "independent" consultants with no acknowledgment of all the hidden assumptions.

Europe has serious troubles, but we don’t

2012-01-30T09:53:00.000+11:00

The economic news from Europe in recent days hasn’t been good. And it could get worse as the year progresses. Those guys have big problems. But let’s not spook ourselves by imagining it to be any worse than it is.

Unfortunately, there’s been a tendency in parts of the media to convey an exaggerated impression of how bad things are and of the extent to which Europe’s problems translate into problems for us.

Take last week’s downwardly revised forecast for the world economy in 2012 from the International Monetary Fund. We heard a lot about the fund’s dire warnings of what could happen if the Europeans didn’t get their act together, but what wasn’t made clear was that the fund’s actual forecast was for global recession to be avoided.

Though the forecast for growth in the world economy this year WAS cut significantly from the forecast in September, at 3.3 per cent it’s below the long-run average rate of about 4 per cent, but still comfortably above the 2 per cent level generally regarded as representing a world recession.

No one thought it necessary to tell us - even though Wayne Swan reminded journalists of it at his press conference - that, from our perspective, the fund’s revisions were old news. They were surprisingly similar to the revised forecasts the government adopted in its mid-year budget review last November.

The fund has the United States growing by 1.8 per cent this year; Treasury had it at 2 per cent. The fund has the euro area contracting by 0.5 per cent; Treasury had it contracting by 0.25 per cent. For China, the fund has growth of 8.2 per cent, whereas Treasury had 8.25 per cent. For India it’s the fund’s 7 per cent versus Treasury’s 6.5 per cent.

Bottom line? The fund has the world growing by 3.3 per cent, whereas Treasury had it at 3.5 per cent.

Journalists are always criticising politicians for repeatedly re-announcing new spending programs, thus leaving the public with an inflated impression of how much is being spent. But journos aren’t above doing much the same thing.

We get a fuss when the government revises down its forecasts in November, then another fuss when the fund announces essentially the same revisions. And in between we get a fuss when the World Bank announces its revisions. Three for the price of one.

Actually, you can understand why the uninitiated got excited about the bank’s revisions. Whereas Treasury had forecast world growth of 3.5 per cent, the bank revised its forecast down to just 2.5 per cent. But no one remarked on that, just as they didn’t seem to notice when, only a week later, the fund put its prediction at a seemingly healthier 3.3 per cent.

So which one is right? They all are. That’s to say, they’re all saying the same thing. I find it hard to understand how anyone who knew their business could bang on about how low the bank’s forecast was without pointing out that it does its forecasts on a different and inferior basis to everyone else.

Whereas our Reserve Bank and Treasury, and the fund, add each country’s gross domestic product together using exchange rates that take account of the US dollar’s widely differing purchasing power in each country, the World Bank doesn’t bother. It uses market exchange rates.

So it perpetually understates the rate of growth in the emerging economies of Asia, thereby understating world growth, since most of it has for quite some years come from Asia. But not to worry. If you took the fund’s country-by-country forecasts and added them together the same misleading way the bank does, what would you get? Growth of 2.5 per cent. Same forecast on either basis.

The trouble with all these forecasts and pronouncements from international agencies is it’s hard for the public to assess what they amount to by the time they reach our shores. These pronouncements rarely mention Australia. And shock waves from Europe have to come to us via China, India and the rest of Asia.

I think the media could try harder to bridge this gap rather than leaving us with the vague impression disaster for Europe means disaster for Australia. Actually, what matters for us is not world growth so much as the growth in our major trading partners, with each partner’s contribution weighted according to its share of our exports.

When Treasury did this sum in the mid-year review, growth in the world economy of 3.5 per cent translated to growth in our major trading partners of 4.25 per cent. All this despite Europe’s recession.

Fran Kelly of Radio Nation Breakfast did go to the trouble of asking the lead author of the fund’s World Economic Outlook, Jorg Decressin, what the revised forecasts meant for us. His reply deflated most of the hype we’ve been subjected to.

‘Australia will be affected by these downgrades only to a limited extent,’ he said. Oh. ‘At this stage, growth in output for Australia is still reasonably strong.

‘Growth in Australia is importantly driven by major investment projects that are in the pipeline and these are funded by strong multinationals that don’t have problems assessing funding.’ Oh.

‘There is no advanced economy - or maybe there are one or two - that is as well placed as Australia in order to combat a deeper slow down, were such a slowdown to materialise and that’s because, well, you still have room to cut interest rates if that was necessary and you also have a very strong fiscal [budgetary] position,’ he said.

Do you get the feeling you’ve heard all this before? Maybe it’s true.

All hail mighty Aussie dollar, as it's here to stay

2012-01-28T07:14:00.003+11:00

This year we'll see more painful evidence of Australian businesses accepting the new reality: our dollar is likely to stay uncomfortably high for years, even decades.

It has suited a lot of people to believe that just as the resources boom would be a relatively brief affair, so the high dollar it has brought about wouldn't last.

If there were no more to the resources boom than the skyrocketing of world prices for coal and iron ore, that might have been a reasonable expectation. But the extraordinary boom in the construction of new mining facilities makes it a very different story.

The construction boom is likely to run until at least the end of this decade, maybe a lot longer. The pipeline of projects isn't likely to be greatly reduced by any major setback in the world economy. That's particularly because so much of the pipeline is accounted for by the expansion of our capacity to export natural gas. The world's demand for gas is unlikely to diminish.

Last time I looked, the dollar was worth US105?, compared with its post-float average of about US75?. But that's not the full extent of its strength. At about 81 euro cents and 67 British pence it's the highest it's been against those currencies for at least the past 20 years.

In the context of the resources boom, the high exchange rate performs three economic functions. First, it helps to make the boom less inflationary, both directly by reducing the prices of imported goods and services and indirectly by lowering the international price competitiveness of our export- and import-competing industries.

Second, by lowering the prices of imports, it spreads some of the benefit from the miners' higher export prices throughout the economy. In effect, it transfers income from the miners to all those consumers and businesses that buy imports, which is all of them. So don't say you haven't had your cut.

Third, by reducing the price competitiveness of our export- and import-competing industries, it creates pressure for resources - capital and labour - to shift from manufacturing and service export industries to the expanding mining sector.

That is, it helps change the industry structure of the economy in response to Australia's changed "comparative advantage" - the things we do best among ourselves compared with the things other countries do best.

As businesses recognise the rise in the dollar is more structural than temporary and start adjusting to it, painful changes occur, including laying off workers. Paradoxically, this adjustment is likely to raise flagging productivity performance.

Economists have long understood that the exchange rate tends to move up or down according to movement in the terms of trade (the prices we receive for exports relative to the prices we pay for imports). This explains why the $A has been so strong, for most of the time, since the boom began in 2003.

But here's an interesting thing. In the December quarter of last year, our terms of trade deteriorated by about 5 per cent as the problems in Europe caused iron ore and other commodity prices to fall. They probably fell further this month.

This being so, you might have expected the $A to fall back a bit, but it's stayed strong and even strengthened a little. Why? Because when the terms of trade weakened, other factors strengthened. The main factor that's changed is the rest of the world's desire to acquire Australian dollars and use them to buy Australian government bonds.

Indeed, the desire to hold Australian bonds was so strong it more than fully financed the deficit on the current account of the balance of payments in the September quarter. It may have done the same in the December quarter. Among the foreigners more desirous of holding our bonds are various central banks.

Remember that, at the most basic level, what causes the value of the $A to rise on any day is that people want to buy more of them than other people want to sell. The price rises until supply increases and demand falls sufficiently to make the two forces equal.

So economists' theories about what drives the value of the $A are just after-the-fact attempts to explain why the currency moved the way it did. We know from long observation that there's a close correlation between our terms of trade and the $A.

But we also know this correlation is far from perfect. There have been times when the two parted company for a while. It's apparent the dollar is driven by different factors at different times.

And it now seems apparent that our relatively superior economic performance and prospects are taking over as the main factor driving the dollar higher (even though our terms of trade would have to deteriorate a mighty lot further before they were back to their long-term average).

There are various reasons why foreign investors (including central banks with currency reserves that have to be parked somewhere) would like to increase their holdings of Australian government bonds.

For a start, we're now one of the few "sovereigns" (national governments) still with a AAA credit rating. For another, the yield (effective interest rate) on Australian 10-year government bonds is almost 4 per cent, compared with about 2 per cent on US Treasury bonds or German bunds.

And the present and prospective state of our economy is a lot healthier than that of the North Atlantic and Japanese economies. Why are our prospects so much brighter and our interest rates higher? In short: the mining construction boom, of course.

It seems clear the world's financial investors are shifting their portfolios in favour of $A-denominated financial assets. And remember, because they're so much bigger than we are, what's only a small shift for them is a big deal for us.

All this suggests the Aussie will stay strong, even as our terms of trade fall back. Remember, too, the huge spending on mining construction over the years will require a lot of foreign financial capital to flow into Australia, helping keep upward pressure on the exchange rate.

This doesn't say the $A has become a safe-haven currency. Were some sudden disaster to occur in Europe it would probably take a dive as frightened investors rushed to the safe haven of US Treasury bonds.

But it probably wouldn't take long for the Aussie to recover - just as it didn't take long after the sudden disaster of the collapse of Lehman Brothers in 2008.

Economic fixes must offer a fair go for all

2012-01-25T11:01:00.002+11:00

When you listen to street interviews with people in the troubled countries of the euro zone, a common complaint emerges: whereas some people waxed fat in the boom that preceded the crisis, it's ordinary workers who suffer most in the bust, and they and even poorer people who bear the brunt of government austerity campaigns intended to fix the problem.

In other words, achieving a well-functioning economy is one thing; achieving an economy that also treats people fairly is another. Economists and business people tend to focus mainly on economic efficiency; the public tends to focus on the fairness of it all.

Fail to fix the economy and almost everyone suffers. But offend people's perceptions of fairness and you're left with a dissatisfied, confused electorate that could react unpredictably.

The trick for governments is to try to achieve a reasonable combination of both economic efficiency and fairness. Fortunately, but a bit surprisingly, the need for this dual approach has penetrated the consciousness of the Organisation for Economic Co-operation and Development - the rich nations' club which is expanding its membership to include the soon-to-be-rich countries.

New research from the organisation deals with ways governments can get their budgets back under control without simply penalising the vulnerable and ways they can improve the economy's functioning and increase fairness at the same time.

Much of the concern about fairness in the hard-hit countries of the North Atlantic has focused on bankers. In the boom these people made themselves obscenely rich by their reckless, greedy behaviour, eventually bringing the economy down and causing many people to lose their businesses and millions to lose their jobs.

But their banks were bailed out at taxpayers' expense - adding to the huge levels of government debt the financial markets now find so unacceptable - and few bankers seem to have been punished. Some have even gone back to paying themselves huge bonuses.

It's a mistake, however, to focus discontent on the treatment of a relative handful of bankers. The fairness problem goes much wider. In most developed countries, the long boom of the preceding two decades saw an ever-widening gap between rich and poor.

In the United States, almost all the growth in real income over the period has been captured by the richest 10 per cent of households (much of it going to the top 1 per cent), so that most Americans' real income hasn't increased in decades.

It hasn't been nearly as bad in Australia. Low and middle household incomes have almost always risen in real terms, even though high incomes have grown a lot faster.

Looking globally, a lot of the widening in incomes has come from the effects of globalisation and, more particularly, technological change, which has increased the wages of the highly skilled relative to the less skilled. But a lot of the widening is explained by government policy changes, such as more generous tax cuts for the well-off.

The euro zone countries need not only to get on top of their budgets and government debt, but also to get their economies growing more vigorously. So the organisation has proposed structural reforms - we'd say microeconomic reforms - which can foster economic growth and fairness at the same time.

One area offering a "double dividend" is education. Policies that increase graduation rates from secondary and tertiary education hasten economic growth by adding to the workforce's accumulation of human capital while also increasing the lifetime income of young people who would otherwise do much less well.

Promoting equal access to education helps reduce inequality, as do policies that foster the integration of immigrants and fight all forms of discrimination. Making female participation in the workforce easier should also bring a double dividend.

Surprisingly - and of relevance to our debate about Julia Gillard's Fair Work Act - the organisation acknowledges the role of minimum wage rates, laws that strengthen trade unions, and unfair dismissal provisions in ensuring a more equal distribution of wage income.

It warns, however, that if minimum wages are set too high they may reduce employment, which counters their effect in reducing inequality. And reforms to job protection that reduce the gap between permanent and temporary workers can reduce wage dispersion and possibly also lead to higher employment.

Systems of taxation and payments of government benefits play a key role in lowering the inequality of household incomes. Across the membership of the organisation, three-quarters of the average reduction in inequality achieved by the tax and payments system come from payments. Means-tested benefits are more redistributive than universal benefits.

Reductions in the rates of income tax to encourage work, saving and investment need not diminish the inequality-reducing effect of income tax, provided their cost is covered by the elimination of tax concessions that benefit mainly high income earners - such as those for investment in housing or the reduction in the tax on capital gains. Getting rid of these would also reduce tax avoidance opportunities for top income earners.

So it's not inevitable that the best-off benefit most during booms and the worst-off suffer most in the clean-up operations after the boom busts. It's a matter of the policies governments choose to implement in either phase of the cycle.

You, however, may think it's inevitable that governments choose policies that benefit the rich and powerful in both phases.

But we're talking about the government of democracies, where the votes of the rich are vastly outnumbered by the votes of the non-rich. So if governments pursue policies that persistently disadvantage the rest of us, it must be because we aren't paying enough attention - aren't doing enough homework - and are too easily gulled by the vested interests' slick TV advertising campaigns.

Moneyball shows competition isn’t always a winner

2011-12-26T07:18:00.001+11:00

One of my favourite films for this year was Moneyball. Ostensibly, it's the story of how the real-life Billy Beane (Brad Pitt), general manager of the Oakland As baseball team, took the second-poorest team in the comp almost to the top.

At a deeper level, it's about how the super-cool guys of professional baseball got beat by the nerds.

It's about how the science of statistics can tell us things we didn't know about our world.

It's about the ultimate make-or-buy decision facing businesses: do you select and train up your own people, or go out and poach someone whenever you need a new heavy-hitter.

But, above all, it's about how competition in markets can fail to live up to its advertising. (If you didn't catch all those levels, read the book by Michael Lewis - much better than the movie.)

Professional baseball in America is a market. All the teams are privately owned businesses, the owners of which are out to maximise profits.

(That's in theory. In practice, many of the owners probably treat their team as an indulgence - a way to enjoy their fortune - as much as a way to increase their fortune; an end as much as a means.)

Beane was so short of money he turned to a bunch of highly educated baseball tragics, who thought studying a potential player's statistical record through high school and college baseball was a better way of predicting his success in the big league than relying on the judgment of talent scouts.

Much to the amazement and disapproval of the traditionalists - and despite their opposition - Beane and the nerds were proved right. Eventually, other teams started copying their methods.

This says to me that, contrary to the assumption of the economists' conventional model, all the guys running all the teams weren't playing for keeps until Beane and his nerds came along.

They wanted to win the comp, but they wanted to win while playing by the unwritten rules - the game's long-established social norms - of how you should go about winning.

To them, picking players by resort to a laptop full of statistics was almost as unsporting as using performance-enhancing drugs.

Here's the point: they didn't want to win for the money - as the model assumes - they wanted to win to impress the other guys in the comp. They were playing a game, not profit-maximising.

Economists portray competition as the foolproof path to efficiency and affluence. And the idea of living in an economy without competition - where everything was supplied by monopolies, whether privately or publicly owned - has zero appeal. Competition does help keep people on their toes.

But competition isn't the unmitigated blessing economists often assume it to be. As I discussed on Saturday, Robert Frank, in his latest book, The Darwin Economy, elucidates the case where competition leads to socially wasteful arms races, where what's good for the individual isn't good for the group.

The conventional model assumes we seek to maximise absolute values: businesses maximise profits, consumers maximise utility.

In real life, however, we're often more concerned about relative values: with how our salary compares with other people's, with whether our firm has the biggest market share. We care most about how we rank.

A related competitive failure occurs when firms (and the individuals who make them up) break (Hugh) Mackay's Law of competition: focus on the customer, not your competitor.

Thanks to their defective model of human behaviour, economists assume we compete only in response to monetary incentives. They forget the urge to compete is hardwired in the brain of the human animal.

We compete because we enjoy competing. We compete because we want to see how we rank in the comp - and we're confident we'll rank well. This, much more than greed, is what motivates the world's billionaire entrepreneurs.

We compete to impress the other players in the game. But when we do, we break Mackay's Law and our efforts don't benefit the community the way the model predicts.

Speaking of misguided competition, consider this from The Economist's Schumpeter column: "The vast majority of American universities are obsessed by rising up the academic hierarchy, becoming a bit less like Yokel-U and a bit more like Yale.

"Ivy League envy leads to an obsession with research. This can be a problem even in the best universities: students feel short-changed by professors fixated on crawling along the frontiers of knowledge with a magnifying glass.

"At lower-level universities it causes dysfunction. American professors of literature crank out 70,000 scholarly publications a year, compared with 13,757 in 1959.

"Most of these simply moulder: Mark Bauerlein of Emory University points out that, of the 16 research papers produced in 2004 by the University of Vermont's literature department, a fairly representative institution, 11 have since received between zero and two citations.

"The time wasted writing articles that will never be read cannot be spent teaching.

"In Academically Adrift, Richard Arum and Josipa Roksa argue that over a third of America's students show no improvement in critical thinking or analytical reasoning after four years in college."

Clearly, and despite all its virtues, competition can sometimes do more harm than good. But don't be so sure the American unis' misguided motivations could easily be corrected by applying some KPIs - key performance indicators.

It's a safe bet those universities have already been using KPIs to reinforce their academics' obsession with publishing or perishing.

In Australia, our governments have long allowed academic-dominated research councils to hand out research grants in ways that discourage our academics - certainly the economists - from researching Australian issues.

A little regulation brings out the best for all of us

2011-12-24T08:34:00.000+11:00

Ask economists who is the father of economics and almost all of them will say Adam Smith. But a new book makes the amazing claim the true father is Charles Darwin. And if you ask economists the question in 100 years' time, that's what they'll say.

The book is The Darwin Economy, by Robert Frank, professor of economics at Cornell University.

Smith was the Scottish moral philosopher, who published his most famous work, The Wealth of Nations, on the eve of the industrial revolution in 1776 (just a few years after Captain Cook visited Botany Bay).

Among all his insights about how the economy works, the one for which he gets most credit is the "invisible hand". This is the notion that impersonal market forces channel the behaviour of greedy individuals to produce the greatest good for all.

Why does a business owner go to the trouble of designing a new product that consumers are likely to find appealing? Why does he invest such effort to revamp his production process to reduce costs? Simply to make more money - as many people realised before Smith.

What they didn't see was the response those actions would provoke from rival business owners, and how the ensuing dynamic - the invisible hand - would produce outcomes very different from those intended, Frank says.

If one producer comes up with a cheaper way of manufacturing a product, he can cut his price slightly and steal market share from his rivals. In the short run, his profits soar, just as he'd hoped. But the loss of market share by rival firms gives their owners a powerful incentive to mimic the original innovation.

And once the innovation spreads industry-wide, the resulting competition drives the product's price down to a level just sufficient to cover the new, lower production costs. The ultimate beneficiaries of all this are consumers, who enjoy steadily improved products at ever-lower prices.

There's much truth to this and it does much to explain why the market system has raised our material standard of living so far over the past 200 years.

So why does Frank then think economists will come to see Darwin as the true father of economics rather than Smith? Because Darwin's study of the natural world led him to a deeper insight about the often flawed nature of competition.

Although Smith was careful not to claim it, many economists (and many libertarians) have taken his invisible hand to mean that regulation of markets is unnecessary and undesirable because unbridled market forces can take care of things quite nicely on their own.

In fact, Smith was well aware that unregulated markets didn't always produce the best outcomes. For the most part, however, he imagined market failure to be the result of inadequate competition. Firms would find some way to nobble their competitors and overcharge their customers.

Critics on the left have long focused on anti-competitive behaviour as the key to understanding why markets fail. But they (and Smith) are missing an important point.

"Darwin's view of the competitive process was fundamentally different," Frank says. "His observations persuaded him that the interests of individual animals were often profoundly in conflict with the broader interests of their own species."

Consider the outsized antlers of bull elk. These antlers function as weapons not against predators but in the competition among bulls for females. Since the bull with the biggest antlers gets to mate with the females, while the others don't, the process of natural selections has given male elk ever-bigger antlers.

But big antlers are a big disadvantage when elk are being preyed on, making them more likely to be killed and eaten by wolves. So what's in the interests of the individual bull is actually contrary to the interests of the group.

While no individual bull would want to be disadvantaged by having smaller antlers than the others, all the bulls would be better off if all of them had the width of their antlers narrowed by, say, half a metre (which would leave the relative size of their antlers unchanged).

You can tell the same story about peacocks' tails, huge elephant seals and many other animals that compete to be the sexual top dog. They all suffer a "collective action problem" - they're locked in a kind of arms race from which no individual can escape, even though all individuals realise how costly the race is. The only solution to the individuals' problem is for the animals - human animals - to act collectively. For them all to agree on a truce - a strategic arms limitation treaty, so to speak - or for some external authority, such as a government, to impose a solution on all of them. All would benefit from such an imposition so, contrary to the assumption of the libertarians, all are likely to welcome it.

The Nobel-prize-winning American economist, Thomas Schelling, quotes the case of ice-hockey players. When helmet-wearing is voluntary, no one is prepared to suffer the small competitive disadvantage of wearing one. But, since helmets do increase safety, all players would vote to make them compulsory.

Frank argues that for competition to give rise to collective action problems - wasteful arms races, if you like - is more the rule than the exception. Why? Because in many important areas of life, performance is "graded on the curve". It's not your absolute score that matters, it's your relative score - that is, where you rank in the comp.

"The dependence of reward on rank eliminates any presumption of harmony between individual and collective interests," Franks says, "and with it, the foundation of the libertarian's case for a completely unfettered market system."

Frank says since individual humans' reproductive success has always depended first and foremost on "relative resource holdings" - which males look the best physical specimens and the best providers; which females look the best child-bearers and homemakers - it would be astonishing if the evolved brain didn't care deeply about relative position.

Hence the tendency as we become ever-more affluent for a growing share of our income to be spent on "positional goods" - that is goods or services which, as well as doing whatever it is they are supposed to do, also signal to the world by their expensiveness our superior position in the pecking order.

Frank concludes that the real reason we regulate markets is to protect ourselves from the consequences of excessive competition.

How to get more bang from your bucks

2011-12-21T08:51:00.000+11:00

The retailers may be worried we aren't spending enough this Christmas, but that doesn't mean most of us aren't spending a fair bit. We always do. And, of course, for those of us off on summer holidays, the spending doesn't stop on Christmas Eve.

Economists are great apostles of efficiency, which they advocate so we have more money to spend on consumption. Strangely, however, they have little interest in how efficiently we spend our money. Are we spending it in ways that maximise the satisfaction (or "utility") we derive? They hardly know or care.

For advice on consumption efficiency we must turn to the psychologists - particularly those who study happiness (another word for utility). Earlier this year three famous psychologists, Elizabeth Dunn, of the University of British Columbia, Daniel Gilbert, of Harvard, and Timothy Wilson, of the University of Virginia, published an article called, If money doesn't make you happy, then you probably aren't spending it right.

The truth is, once you've satisfied your basic needs, getting and spending more money is a progressively less effective way to make yourself happier. The more you spend, the less effective each extra dollar becomes.

But that's partly because some forms of spending are more satisfying than others, and Gilbert's research shows humans aren't very good at predicting what will make them happy.

So the authors propose some principles that psychological research suggests will help us get more bang from our bucks. One that's particularly apposite at this time when we celebrate the birth of Santa is: help others instead of yourself.

Somebody who had nothing to do with Santa once said it was more blessed to give than to receive. Turns out he was right. Dunn has done various experiments that show giving gifts to people or making donations to charity makes people happier than spending money on themselves.

Studies of people's brains using magnetic resonance imaging showed that when people chose to give money to a local food bank this caused activity in the part of their brain typically associated with receiving rewards.

Why should this be? Because humans are the most social animal on the planet, the quality of our social relationships is a strong determinant of our happiness. So almost anything we do to improve our connections with others tends to improve our happiness as well.

Particularly at this time of year, retailers try to entice us with offers to "buy now, pay later". I don't doubt this helps increase sales, but it's pretty much the opposite of how you gain greater satisfaction. Another principle the authors propose is: pay now and consume later.

Consume now, pay later is a bad idea because it eliminates anticipation, and anticipation is a source of "free" happiness, the authors say. Delayed gratification means you get the pleasure of thinking about how good it will be and then you get the pleasure of actually experiencing it. We also get pleasure from looking back on experiences, but we get more from anticipating them.

A third principle is: beware of comparison shopping. The trouble with comparison shopping is it focuses your attention on those attributes of the items that are easily compared, not necessarily the attributes most important to how much satisfaction you'll get from the item once you've got it home and are using it.

This may be particularly true of internet shopping, which is likely to increase the emphasis on the attribute that's most easily compared: price. That's fine - especially when you're comparing identical items. But price is only one consideration. More important ones are whether you really want the thing in the first place, and how much use you're likely to make of it.

The next principle seems odd: follow the herd instead of your head. Research suggests the best way to predict how much we'll enjoy an experience is to see how much someone else enjoyed it. That's because we're so bad at predicting our utility. It's probably also because, being such intensely social animals, we usually feel comfortable doing what everyone else is doing (even if we don't like admitting it).

Next: buy many small pleasures instead of a few big ones. Present-buying parents, please note. The reason the pleasure from acquiring new things wears off so soon is that we so quickly get used to them. Psychologists say we "adapt" to them. So a key tactic in seeking to increase the pleasure we get from things is to find ways of slowing our rate of adaptation. One way to do it is to buy a lot of little things and get satisfaction out of each of them rather than buy a few big hits.

And they say economists use jargon. See if you can translate this: "Across many different domains, happiness is more strongly associated with the frequency than the intensity of people's positive affective experiences." (Positive affect means good feelings.)

In a study of Belgians, those who had a strong capacity to savour the mundane joys of daily life were happier than those who didn't.

I've left for last a principle I've written about before: buy experiences instead of things. We adapt to the ownership of things more quickly than to experiences. We anticipate and remember experiences more than things.

Our experiences are more centrally connected to our identities. And experiences are more likely to bring us into connection with other people.

Turns out this is the retailers' problem. We're not spending less overall, we're just spending less of our income on the goods retailers sell and more on the services they don't. Overseas holidays, for instance. But not for me, this time. Come Boxing Day I'm off up the coast for a few weeks.

Secret of successful economy is 'frameworks'

2011-12-19T10:05:00.002+11:00

The proof we suffer from an economic cringe as well as a cultural one is our tendency to attribute our better position relative to the other advanced economies purely to good luck. In truth, it's owed as much to our markedly superior economic management over the past 20 years.

What? Poor little Oz runs its economy far better than the mighty Yanks and the haughty Europeans? You betcha.

Last week both Ric Battellino, deputy governor of the Reserve Bank, and Dr Martin Parkinson, secretary to the Treasury, warned we would not be immune from the public debt troubles of Europe and the United States.

However, Parkinson said, we can take some comfort from our starting position. ''We are located in the fastest growing region in the global economy with a number of opportunities likely to present themselves over the next decade,'' he said.

''Equally, the flexibility of our economy and our medium-term oriented policy frameworks have assisted Australia manage the impacts from external volatility.''

According to Battellino, we need to monitor the unfolding European situation carefully and remain alert to the risks. ''Having said that, I remain confident that Australia, with its strong government finances, resilient banking system, relatively low exposures to the troubled countries and strong links to the dynamic Asian region, is well placed to deal with events that may unfold,'' he said.

So it's true we're enjoying the good luck of being close to Asia and loaded with the very natural resources it's willing to pay so dearly to get its hands on. But it's also true our leaders have understood the need for us to ''enmesh'' our economy with Asia's since Malcolm Fraser's day, and have worked towards that end.

Our econocrats can take a lot of the credit for the sound state of our banks. They didn't fall for - and didn't let their political masters fall for - all the happy talk about deregulation and free markets.

But wait, there's more - much more. And Battellino offered a big clue to it. He noted that government debt in the euro area had been rising as a proportion of gross domestic product for much of the period since the 1970s.

''This occurred because governments loosened fiscal [budgetary] policy during recessions, but did not fully reverse those policies during the subsequent cyclical recoveries,'' he said. ''In aggregate, budgets in the countries that now form the euro area have been continuously in deficit for the past 40 years.''

And here's the clue: ''Clearly, there was no fiscal rule that aimed to balance the budget over the economic cycle, as there is in Australia.''

He could have said much the same about the build up of public debt in the US, which saw its credit rating downgraded this year and looks likely to induce a fiscal crunch in 2013.

The truth is our economy was quite badly managed in the 1970s and much of the '80s. But whereas that's still true of Europe and the US, it hasn't been true of us for at least the past 20 years - during which time, you'll recall, we haven't had a serious recession, while the others have had two or three.

So what's the secret of our success? Our econocrats' commitment to making the conduct of fiscal policy and monetary (interest-rate) policy subject to clearly defined medium-term ''frameworks'' - systems of rules and targets - so as to reduce their susceptibility to short-term political expediency.

With monetary policy, that's been straightforward. In 1993, then Reserve Bank governor Bernie Fraser joined the international trend for monetary policy to be conducted by the central bank independent of the elected government, guided by an inflation target. Fraser's genius was in specifying such a sensible, flexible target: 2 per cent to 3 per cent on average over the cycle.

This regime was adopted formally by the incoming Howard government in 1996. The framework has achieved its goal of reducing and ''anchoring'' inflation expectations, so the target has been achieved without great restraint on economic growth. And successive governments - Liberal and Labor - have copped without anything more than a grumble all the Reserve's moves to raise interest rates at politically inconvenient times.

As the towering public debts of the North Atlantic economies attest, the pursuit of a framework for fiscal policy has been much more our own work, with little overseas precedent to guide us. It began with the ''trilogy of commitments'' unveiled in the Hawke government's first budget of 1983, and was reinforced with new targets for reducing the budget deficit in the Keating government's post-recession budget of 1993.

But the biggest stride towards a rigorous framework came with Peter Costello's enactment of the Charter of Budget Honesty upon election in 1996. At the charter's centre was Costello's ''medium-term fiscal strategy'' to ''maintain budget balance, on average, over the course of the economic cycle''. He lived by this strategy, achieving 10 budget surpluses during his term, before the onset of the global financial crisis (to which should be added Keating's three surpluses before the recession of the early '90s).

The present Labor government endorsed the Libs' medium-term strategy and its response to the crisis was consistent with it. In Labor's second stimulus package of February 2009 it conformed to the charter's requirement that it spell out a ''deficit exit strategy'', choosing to limit real growth in its spending to 2 per cent a year and forswearing any further tax cuts until a healthy budget surplus was restored.

''Frameworks'' are a boring subject, little mentioned by the media. But they've been our secret weapon in producing vastly superior outcomes to the Europeans and the Yanks.

Economy follows wherever our moods take us

2011-12-17T07:53:00.000+11:00

To anyone but the economists and financiers, getting to the bottom of what the problem is in Europe is hellishly complicated. The more you read the more confused you get. But you can boil it down to the combination of the availability of credit and what Keynes called ''animal spirits''.

To anyone but the economists and financiers, getting to the bottom of what the problem is in Europe is hellishly complicated. The more you read the more confused you get. But you can boil it down to the combination of the availability of credit and what Keynes called ''animal spirits''.

Animal spirits refer to the tendency of the human animal to go through alternating waves of excessive optimism and excessive pessimism. Because we're a highly social animal, we tend to all be optimistic or pessimistic together. Animal spirits are contagious.

In principle, the availability of credit is a wonderful thing, allowing families to buy a home long before they could pay cash for it and businesses to expand beyond their owners' savings.

Taken separately, the existence of credit and animal spirits isn't a big problem. Taken in combination, however, they can be lethal. Animal spirits - also known as ''confidence'' and ''expectations'' - are the main factor causing the economy to speed up and slow down, speed up and slow down again.

Add the availability of credit - which, once availed of, becomes debt - and the amplitude of the ups and downs is greatly increased to produce the business cycle of boom and bust.

The potentially toxic combination of credit and confidence can be a problem for households, businesses, banks or governments. The risk is they borrow too much while everyone's confident the present up-and-up will last forever, then get into trouble when the mood switches and everyone fears the end is nigh.

In Europe's case the main problem is with excessive borrowing by governments. As Ric Battellino, retiring deputy governor of the Reserve Bank, explained this week, government debt in the euro area has been growing faster than gross domestic product for the past 40 years.

The 17 countries' combined net public debt at the start of the global financial crisis equalled about 45 per cent of GDP. Since then it's jumped a third to 60 per cent. If those net figures don't impress you (most of those you see are gross, taking no account of the countries' financial assets), note that these euro-wide averages include Greece with a net debt of about 130 per cent of GDP and Italy with about 100 per cent.

The trouble with debt, of course, is it has to be ''serviced''. You have to pay the interest as it falls due and sometimes also repay part of the principle. Businesses and governments tend not to repay their borrowings but just roll them over (renew them)when they come to the end of their term.

You pay interest out of current income. This is rarely much of a problem while everyone's optimistic and your income keeps growing. But when the mood swings to pessimism and the economy turns down - or when the economy turns down and the mood swings to pessimism; it's often hard to be sure which causes which - it can get a lot harder to keep up your interest payments when your income isn't growing as fast or is falling.

The trouble with interest payments, of course, is they're not optional. Many households and firms have to cut back their other spending to make sure they can make their interest payments. When too many of them have to do that, the economy takes another lurch down, taking confidence with it.

Governments, on the other hand, tend merely to run bigger budget deficits. But when you're borrowing just to meet your interest payments, your debt and your interest payments grow rapidly.

And you find you've got another problem. The very people who lent to you so happily during the optimistic phase now turn on you. They say you're a hopeless money-manager, they worry about whether they'll get their money back, they'll only lend you more money at a much higher interest rate and may even press you to repay some principal.

Whereas during the optimistic phase they probably didn't charge you an interest rate high enough to adequately reflect their risk that you wouldn't be able to repay them, in the pessimistic phase - when you're at your most vulnerable - they probably charge you more than needed to cover that risk.

It's all terribly illogical, unfair and, worse, counterproductive. The people who shouldn't have lent you so much blame you, not themselves. They go from being too optimistic, to too pessimistic; too easy to too tough. And by doing so they threaten not only your survival, but their own.

Great system, eh? It's one of the great weaknesses of the generally highly beneficial capitalist system. It occurs because the humans who inhabit the system are emotional, herd animals, contrary to economists' happy assumptions that we're all rational and markets never get it wrong. It occurs when, as until recently, economists, regulators and politicians start believing their own bulldust.

All this helps explain why the governments of the euro area, having borrowed far more than they should have over many years, are now in so much trouble. Some, of course, have borrowed a lot more than others. These are the ones in the most trouble. But since they're all yoked together in the euro, they're all in trouble together.

Once the worst case - Greece - focused their attention, the financial markets began turning one by one on the other bad cases, as markets do. Trouble is contagious. Even the strong countries - Germany and France - are sus because their strength may not be sufficient to prop up all the others.

In the modern world, countries aren't allowed to go bankrupt. They always get bailed out, usually by the International Monetary Fund. In the case of the euro area, much of the bailing out will probably be done by the European Central Bank.

But salvation for sinners always comes with hefty punishment attached, to make sure they learn their lesson. Punishment comes in the form of ''austerity'' - big cuts in government spending and increases in taxes - which initially make things worse rather than better.

At present we're going through a drawn-out period of uncertainty while all the politicians involved argue about taking their medicine. I'm confident they'll eventually get their act together but, even if they do, Europe is in for an unpleasant decade.

PM Gillard: hard worker, hard-nosed, hard to read

2011-12-14T09:22:00.000+11:00

Having observed Julia Gillard's government for more than a year, I must say she's hard to pigeon-hole. Is the woman who changed the government's mantra from "working families" to "hard-working families" a typical Labor prime minister, as many business critics of Fair Work believe, or a pale imitation of a Liberal leader, as her willingness to sell uranium to India and her opposition to same-sex marriage lead many critics on the left to conclude? Does she stand up to powerful industries or kowtow to them?

You can make a surprisingly long list of social changes you'd expect the Labor heartland to be pretty happy about (even though it seems far from enamoured of its first female federal leader).

The introduction of paid parental leave (which, admittedly, occurred under Kevin Rudd) is an important step in reforming the institutions of the labour market to make them more suited to the needs of the better-educated sex.

Equal pay for women in the community sector - most of the cost of which will be borne by the federal budget - remedies an age-old injustice, which never made sense and couldn't have survived in a world of shortages of labour.

Plain-packaging for cigarettes is preventive-health reform that leads the world. The international tobacco industry has few friends, but very deep pockets to fight the Gillard government with advertising and legal action.

But global tobacco has a fraction of the power the licensed clubs have in opposing compulsory pre-commitment for people using poker machines. Although this issue was forced on Gillard by her lack of a majority, she has yet to waver in her determination to get it passed by Parliament. And though it, too, is a reform without international precedent, it could do much to reduce the gambling industry's indefensible exploitation of people addicted to poker machines.

Rudd should get most credit for several other social improvements: the national homeless strategy, the national rental affordability scheme (tax breaks for investors in affordable housing) and the first injection of funds into social housing in many a long day.

Rudd started, but Gillard has continued, Labor's many measures to pare back John Howard's middle-class welfare by declaring a family on $150,000 a year to be not rich, but comfortable. These measures don't just save money, they make the budget more redistributive in favour of the genuinely deserving.

And Gillard has defied the powerful private health insurance industry by continuing Rudd's efforts to get means-testing of the health insurance tax rebate approved by Parliament.

Gillard has committed herself to making introduction of a national disability insurance scheme her top social reform in the rest of her term. By providing help to people who inherit their disability or acquire it from an accident around the home, this would fill a longstanding gap in our social safety net. It would be a historic advance (and is one of the few reforms Tony Abbott hasn't opposed).

But against all that there are a couple of areas where Gillard's performance has been anything but what you would expect from Labor. The first is her education "reforms" copied from the American Republican Party.

Trying to "incentivate" school teachers as though they were as money-hungry as chief executives merely insults their professionalism. Providing parents with greater information about the performance of schools is fine, but doing so before summoning the courage to correct the bias in federal school funding in favour of well-off schools risks hanging under-resourced public schools out to dry.

Gillard has spent four years postponing change to Howard's middle-class-welfare school-funding formula. Her response next year to the belated review will show whether her courage has recovered.

The tax concessions attached to superannuation have long been heavily biased in favour of high income earners such as yours truly. To call them middle-class welfare would be an understatement.

Rather than using the opportunity provided by the decision to phase-up compulsory employee contributions from 9 per cent to 12 per cent of salary (a multi-billion-dollar gift to the financial services industry) to shift the tax benefit from high to middle and low income earners, the government will merely use some of the revenue from the mining tax to correct the position where workers on the 15 per cent income tax rate gain no concession on their contributions.

But the most puzzling and indefensible aspect of Rudd policy continued by Gillard is the mistreatment of sole parents and, more so, people on unemployment benefits. Both groups were explicitly excluded from the over-generous pension increase in 2009.

For many years, age and invalid pensions have been indexed to average earnings, meaning they rise faster than inflation, whereas the dole has been indexed only to inflation. In consequence, the dole paid to single adults is now less than two-thirds of the single pension, a shortfall of $131 a week.

The dole is now so low it's just 36 per cent of median household income, putting it well below the commonly drawn poverty line of half median income. It's also just 45 per cent of the after-tax minimum wage - meaning there is little risk its generosity is deterring people from taking a job.

One defence of low unemployment benefits is that most people aren't on them for long. But more than half the people on the dole have been on it for a year or more. And the government is also limiting the assistance it gives the long-term unemployed to help them find a job.

This discrimination against the unemployed is now so extreme the Henry tax reform recommended it be corrected. And even the Business Council agrees.

Perhaps Gillard's lack of sympathy for the unemployed arises because, being unable to find a job, they're not hard-working.

Reserve has re-assessed outlook for world growth

2011-12-12T09:12:00.000+11:00

Just as a stopped clock is right twice a day, so the financial markets' belief that Europe's sovereign debt problems are the primary factor influencing the Reserve Bank's decisions about interest rates, having been wrong for most of the year, has finally proved on the money.

A psychologist would say the financial markets have been suffering a "salience" problem. Their judgments about how the Reserve will adjust the official rate have been overly influenced by the factor sticking out in their minds and also on their minds most recently: Europe.

If Europe is on their front burner, it must also be on the Reserve's. Since the outlook for Europe is so worrying and so conducive to slower economic growth, the markets have for months been predicting that big falls in our official rate are imminent.

Month after month the markets have stuck to this view, ignoring the Reserve's twice-monthly explanations of its thinking, which, while acknowledging the worries and uncertainties over Europe, have repeatedly emphasised the state of the domestic economy and, in particular, the outlook for domestic inflation, as key considerations.

So when, on Melbourne Cup day, the Reserve acted for the first time in a year and chose to lower interest rates by a notch, the markets weren't surprised. But they were right for the wrong reason. As the Reserve made clear, it was able to ease a notch because the economy wasn't accelerating to the extent it had been expecting, thus making the Reserve more confident inflation would stay on track over the next year or two.

But all that changed last week, when the Reserve eased the rate another notch, this time making it clear its decision had been influenced by the changed prospects for the global economy.

So what exactly were its motivations? Was it taking out a little insurance, fearing the worst might come to the worst in Europe? No, nothing so dramatic.

It doesn't take many brain cells to get the wind up over Europe and assume the worst. It takes more brain power to quietly assess the probability of a complete disaster. And more again to assess the strength of any troubles in Europe by the time the ripples reach the Antipodes via China.

By now, the shape of the solution to Europe's problem is reasonably clear. The 17 member countries of the euro area (or, if they insist, almost all the members of the European Union) need to sign up to a new fiscal compact, which imposes limits on the size of their budget deficits and levels of public debt relative to gross domestic product, with automatic penalties for countries that breach these limits.

The pact would also impose timetables for countries presently well in excess of those limits to comply with them, again with penalties for breaches.

Once these strictures had been ratified - thus plugging the obvious hole in the euro currency union, as well as guaranteeing the errant borrowers would mend their ways - the European Central Bank would be willing to start buying up the bonds of member countries, thus forcing down their yields.

It would cut its official interest rate to next to nothing and engage in "quantitative easing" (buying government bonds to cover deficit spending and so, in effect, printing money). Thus all the budgetary contraction would be offset to some extent by monetary stimulus.

While it's painfully apparent the European leaders are having trouble getting their act together - thus increasing the risk of disaster occurring by accident - it's also apparent they're neither fools nor suicidal.

So to assume Europe is headed inevitably for an implosion - as many punters seem to - strikes me as nothing more than unthinking pessimism. Our more experienced observers put the probability of a complete disaster no higher than about one chance in three.

This says the chances are twice as high that Europe will muddle through. But it's clear that even if the full calamity of a collapse in the euro is averted, even if everyone dons their fiscal straitjacket, the financial markets calm down and ordinary life resumes, the outlook for the European economy is particularly weak.

All those economies committed to the fiscal austerity of tax increases and swingeing spending cuts - and it will be quite a few of them - face the dismal prospect of fiscal contraction leading to reduced revenue, reduced revenue leading to a need for more fiscal contraction, and so on and on.

If you wonder how any politician could agree to such an appalling exercise, you're starting to understand why Europe's politicians have had so much trouble getting themselves up to the barrier. They've had to reach the realisation the financial markets - which went for years happily lending them more money than was good for them - are now not going to tolerate any easier or more sensible work-out of their debt problems.

For our purposes, it's now clear the greatest likelihood is negative to flat growth in Europe for at least the next year or two (the forecast period) and probably far longer. It's also clear that, while the US economy has gained momentum recently, it too faces unavoidable fiscal contraction, if not next year then in 2013.

With evidence China's exports to Europe are already being hit, the Reserve decided last week to revise down its forecasts for world growth. This will change its forecasts for domestic growth and inflation only a little, but it was enough to raise the Reserve's confidence it could cut rates another notch without jeopardising achievement of its inflation target.

Meanwhile, the financial markets are betting the official rate will have fallen by another 1.5 percentage points by the middle of next year. I call that courageous.

Nice set of figures should shut up the gloomsters

2011-12-10T14:24:00.000+11:00

Something strange is happening to the Australian psyche at present. A lot of people are feeling down about the economy. They're convinced it's pretty weak, and any bit of bad news gets a lot of attention.

But most of the objective evidence we get about the state of the economy says it is, under the circumstances, surprisingly strong. Consider the national accounts we got this week.

They show the economy - real gross domestic product - grew by 1 per cent in the September quarter, more than most economists were expecting. And not only that, the Bureau of Statistics went back over recent history, revising up the figures.

Originally we were told the economy grew by a rapid 1.2 per cent in the June quarter, but now we're told it grew by an even faster 1.4 per cent. Originally we were told the economy contracted by 1.2 per cent in the March quarter because of the Queensland floods and cyclone, but now we're told the contraction was only 0.7 per cent.

Those figures hardly fit with all the gloominess. So how fast is the economy travelling, on the latest numbers? We're told it grew by 2.5 per cent over the year to September, but that figure includes the once-off contraction in the March quarter, which is now ancient history.

We could do it the American way and say we grew at an ''annualised rate'' of 4 per cent in the September quarter (roughly, 1 per cent x 4), but that's too high because this quarter (and the previous one) includes a bit of ''payback'' (or, if you like, catch-up) as the Queensland economy got back to normal after its extreme weather.

(There's likely to be more catch-up in the present quarter as the Queensland coalmines finally pump out all the water and resume their normal level of exports, suggesting the Reserve Bank is reasonably safe to achieve its forecast of 2.75 per cent growth over the year to December.)

So the best assessment is that at present the economy is growing at about its ''trend'' (long-term average) rate of 3.25 per cent a year. If so, everything's about normal.

Ah yes, say the gloomsters, but all the growth's coming from the mining boom. Before we check that claim, let's just think about it. If we were viewing our economy in comparison with virtually every other developed economy, we'd be thanking our lucky stars for the mining boom.

But not us; not in our present mood. We're feeling sorry for ourselves because, for most of us, the benefits of the boom come to us only indirectly. (The other thing we ought to be thankful for apart from our luck is 20 years of clearly superior management of our economy. In stark contrast to Europe and the US, we have well-regulated banks and stuff-all public debt.)

It's true the greatest single contributor to growth in the September quarter was the boom in investment in new mines. New engineering construction surged 31 per cent in the quarter and total business investment spending rose by almost 13 per cent.

But though most of that remarkable boost is explained by mining, there was also a healthy increase in manufacturing investment.

And here's a point some people have missed: the second biggest contribution to growth in the September quarter (a contribution of 0.7 percentage points) came from the allegedly cautious consumer.

Consumer spending grew by 1.2 per cent in the quarter and by 3.8 per cent over the year to September. That's actually above its long-term trend. And consumer spending was strong in all the states, ranging from rises of 0.8 per cent in Victoria, 0.9 per cent in Western Australia (note) and 1.1 per cent in NSW, to 1.9 per cent in Queensland (more catch-up).

Although households are now saving about 10 per cent of their disposable incomes, this saving rate has been reasonably steady for the past nine months. So consumer spending is growing quite strongly because household income is growing quite strongly.

It's noteworthy that, according to Treasury, non-mining profits rose by 4.7 per cent in the quarter. And according to Kieran Davies, of the Royal Bank of Scotland, non-mining GDP grew by a solid 0.7 per cent in the quarter, just a fraction below trend.

So the notion that mining (and WA and Queensland) might be doing fine but everything else is as flat as a tack is mistaken. It's true, however, that some industries are doing it tough. Consumers are spending at a normal rate, but their spending has shifted from clothing and footwear and department stores to restaurants, overseas travel and other services.

Home-building activity declined during the quarter - a bad sign. The continuing withdrawal of the earlier budgetary stimulus meant that government spending fell by 2.5 per cent during the quarter. Public spending was a drag on growth in all states bar WA and Queensland (more catch-up).

Our terms of trade - export prices relative to import prices - improved by 2.7 per cent in the quarter (and by 13 per cent over the year to September) to be their best on record. But that's likely to be the peak, with key export prices falling somewhat in the present quarter.

The volume of exports rose by 2 per cent in the quarter, but the volume of imports rose by 4.3 per cent, mainly because of imports of capital equipment. So ''net exports'' (exports minus imports) subtracted 0.6 percentage points from overall growth in real GDP during the quarter.

Ah yes, say the gloomsters, but all this is old news - the September quarter ended more than two months ago. The economy must have slowed since then. After all, look at this week's news of a rise in the unemployment rate to 5.3 per cent in November.

It does seem true the labour market isn't as strong as the strength of economic activity would lead us to expect. This could indicate a degree of caution on the part of employers. But the rise in unemployment is slow and small, and if it's only up to 5.3 per cent we're still doing very well by the standard of the past 20 years.

As for the tempting line that everything's gone bad since the strong growth in the September quarter, just remember: that's what the gloomsters said when they saw the good growth figures for the previous quarter. Turned out to be dead wrong.

Breakdown in relations is everyone's business

2011-12-07T10:01:00.000+11:00

I get to meet a lot of famous and interesting people in my job, but few have had more influence on me than Dr Michael Schluter, the social thinker, social entrepreneur and founder of Britain's Relationships Foundation.

They say genius is being the first to say the obvious. If so, Schluter is one. I'm sure Socrates or Aristotle beat him to it but, in our time, Schluter is the first to forcefully remind us of something we all know: the importance of our human relationships.

We are, above all, social animals. After we've secured our physical survival, the most important thing in our lives is our relationships: with friends, neighbours, workmates and, above all, with our families - our parents, siblings, spouse and children.

Even if we've avoided speaking to them for years, even if they're dead and gone, we can't stop thinking about them. If we've cut ourselves off from our families, be sure we've sought to fill the vacuum with other relationships. Take away all our relationships and who'd have much reason to live?

So much for stating the obvious. But here's Schluter's simple, unarguably telling, point: if our relationships are so fundamental to our well-being, why do we keep forgetting to take account of them in our strivings? Wouldn't we be better off if we got into the habit of viewing all our endeavours through a lens that focused on their implications for our relationships?

How often do divorce lawyers advise people to avoid all attempts at reconciliation with their estranged spouse for fear of weakening their legal position? How often do doctors treat physical symptoms that aren't what's really troubling their patient?

How often do politicians who loudly proclaim their support for the family then consider 101 policy proposals without a thought as to their implications for people's relationships? As for economists, their model is so narrowly focused on the individual that they become oblivious to the potential effects of the policies they advocate on the relationships that sustain all individuals.

The truth is much of our ever-increasing material affluence over the past 200 years has been achieved at the expense of our relationships; by making the workings of the economy ever bigger, more complex and impersonal; by encouraging economic transactions between people who've never met, let alone had a relationship with each other.

Back to Schluter's insistent reminder: aren't we paying a price for ignoring the relational implications of all this? Wouldn't we be better off if we put the protection and promotion of our relationships back into the formula?

So far have we strayed from recognising the primacy of our relationships that the proposals of the mild-mannered, respectable, god-fearing Schluter sound positively radical.

About 150 years ago, the invention of the limited-liability company allowed people with money to invest to become owners of companies without taking any part in their management. The development of stock exchanges allowed people to buy and sell their shares in a company as easily and often as they liked. From these innovations came the huge corporations that dominate the economy today.

Economists see them as milestones on our path to prosperity. Schluter sees the downside. So, last month, in troubled Britain, he and a colleague, Jonathan Rushworth, launched a plan, Transforming Capitalism from Within: a Relational Approach to the Purpose, Performance and Assessment of Companies.

He proposes that enlightened firms submit themselves to the discipline of a 10-step ''relational business charter''. Step one is for the company to include in its articles of association a goal to become a profitable and sustainable business for the benefit of all its stakeholders - owners, directors, managers, employees, suppliers and customers - and the wider society.

Step two is to promote dialogue among company stakeholders, preferably through regular, face-to-face meetings.

Step three seeks to reduce ''relational distance'' between shareholders and the employees and other stakeholders by promoting share ownership by named individuals and family trusts rather than institutional investors such as pension funds.

The goal could be 25 per cent direct ownership pursued, partly, by encouraging employees to own shares. Ideally, a growing proportion of shareholders will live close to the company's main base.

Next, to achieve commitment, involvement and responsibility by shareholders, relational firms should encourage long-term ownership, perhaps by issuing additional shares to those who hold their shares for long periods.

Step five is for companies to help their employees achieve work-life balance by minimising long working hours and work at unsociable hours (including weekends) wherever possible. These things have a direct effect on the families of employees, particularly if the employee will not be present to share the bringing up of children.

Then firms will seek to respect the dignity of all employees by minimising remuneration differentials within the business. A ratio of 20:1 between top and bottom would be a good benchmark.

Relational companies will treat suppliers fairly and with respect, paying them promptly and giving them support to develop their businesses.

Relational companies will treat their customers and the local community fairly, respecting their concerns about reasonable payment terms and adequate service.

Step nine involves companies protecting their business and stakeholders by minimising the risk of financial instability, limiting their ''gearing'' - ratio of borrowing to shareholders' funds.

Finally, relational companies will fulfil their obligations to the wider society by paying a reasonable proportion of profits in tax in the country where those profits were earned. They will also spend a reasonable proportion of profits on corporate social responsibility.

The musings of a hopeless dreamer? I think our companies' present ruthless pursuit of profit at any cost is an excess that can't last. Schluter is a prophet pointing the way back to more sensible capitalism.

Business economists play politics over budget surplus

2011-12-05T09:18:00.000+11:00

Business economists have been surprisingly critical of Julia Gillard's efforts to keep her promise to return the budget to surplus next financial year, but if I were her I'd have done much the same thing.

She, her cabinet and her econocrat advisers turn out to have a much better understanding of real-world macro-economic management than the know-it-all business economists.

Their repeated statements that the government's obsession with achieving budget surplus in 2012-13 is a ''purely political'' objective show how little they understand political economy. Paradoxically, it's they who are playing politics in making such a claim.

In an ideal world - a rational world - it wouldn't be necessary for Wayne Swan and Penny Wong to turn the fiscal somersaults they did last week just to keep the budget's forward estimates pointing to a laughably microscopic surplus.

(All the ''reprofiling'' - read creative accounting - to which the budget ministers needed to resort is explained not so much by the economy's now weaker-than-expected strength of recovery, but by the extent to which the carbon tax package was, predictably, revenue negative in its first year.)

In such an imaginary world, it wouldn't matter if the budget's return to surplus was a year or two earlier or later than the year first projected. In such a world, the punters wouldn't imagine a surplus of $1.5 billion was a totally different animal to a deficit of $1.5 billion, instead of the same thing: a near-as-dammit balanced budget.

In such a world, voters would not set the bar higher for Labor treasurers than Liberal treasurers.

In such a world, voters would laugh to scorn the efforts of such reliable witnesses as Tony Abbott, Joe Hockey, Andrew Robb and Barnaby Joyce to convince them all budget deficits are bad and Australia's public debt is mountainous.

But the business economists so freely accusing the government of being ''purely political'' are guilty of more than naivety. Their political double standard is showing.

Where were they with their accusations of politicians being ''purely political'' when, almost from the first fiscal stimulus package, the Liberals began trying to inculcate their pre-Keynesian nonsense in the minds of an economically illiterate electorate?

I don't remember hearing from them. In fact, with the honourable exception of Saul Eslake, I can't remember ever hearing a business economist dare to criticise a Liberal government or opposition.

Under Abbott the Libs are at their most populist, protectionist and anti-rationalist in decades. They've been working overtime to exploit and frustrate any attempt by Labor to implement unpopular reforms. The notion of Abbott in government is frightening.

But do we hear a breath of criticism from the business lobbies or the business economists? Gosh no. The Libs might take offence.

But take a shot at a Labor government, especially one that's out of favour with big business and looks on the ropes? Sure, why not. How could the boss object to that?

Labor's problem is not that it's had bad economic policies - its response to the global financial crisis was almost too successful for its own good; its carbon price scheme was compromised more by the reneged-on deal with Malcolm Turnbull than by the subsequent deal with the Greens - but that it can't explain itself, can't educate the electorate.

Is it surprising politicians adopt less-than-pure policies when they know that, were they to be more courageous, the nation's economists - academic and business - would be missing in action when the guns were firing?

But this episode doesn't just reveal the business economists' partisanship and their dereliction in helping to educate a gullible electorate. It reveals that, even after our experience with the global financial crisis, they don't understand the central role of psychology - confidence - in any government's efforts to manage the economy through the business cycle.

The present low levels of consumer and business confidence are a consequence of various factors, not just forebodings about the turmoil in Europe. Other factors would be fears about the devastating effects of the carbon tax and, after years of propagandising by the opposition and the Murdoch press, a lack of confidence in the government's ability to manage the economy.

In such circumstances, would it really be of no consequence for the government to be seen to have broken its promise to return the budget to surplus? Can you imagine how the opposition would carry on? Do you really think that would have no effect on confidence?

There may even be some truth in the government's argument that, in view of the global financial markets' concerns about sovereign debt, this is no time for our government to renege on promises to stop adding to government debt.

So much for the naive belief the government's concern to protect its reputation as an economic manager is ''purely political''. But wait, there's more.

If there's one lesson to be learnt from the problems in the United States as well as Europe, it's the difficulty governments have in keeping the two sides of their budget within cooee. We, of course, are exemplary by comparison.

Why have we exercised so much fiscal discipline? Because of our tight ''framework'' of rules and targets to guide fiscal policy. Rules and targets governments of both colours have adhered to.

In an ideal world, governments would have no trouble exercising discipline over their spending and taxing. In the real world, governments have to give discipline a helping hand by drawing essentially arbitrary lines in the sand, then sticking to them.

Gillard's promise to achieve a surplus in 2012-13 is just such an arbitrary line. That line could be washed away by a tidal wave from Europe, of course. But sensible economists think twice before urging governments to cast aside their self-imposed pre-commitment devices.

How budget update affects stance of fiscal policy

2011-12-03T11:36:00.000+11:00

The most remarkable thing about this week's mini mini-budget is how many words the media could spill without clarifying a rather important question: how will it affect the economy?

One of the ways politicians (and journalists) make such announcements sound big is by giving us the cost of measures ''over four years''. But the economy is lived through, and managed, one year at a time. So it's the year-by-year figures that matter most.

We know the avowed purpose of the spending and tax measures announced along with the midyear budget update was to get the budget back on track to return to surplus in 2012-13, as Julia Gillard promised in the election campaign.
The return to surplus had been put in doubt by the effect of the turbulence in Europe on the confidence of our consumers and business people, which is stopping the economy growing as quickly as had been expected at budget time.

In consequence, tax collections are now expected to grow by about $5 billion in 2011-12 and $6 billion in 2012-13 less than earlier thought. With other revisions, this would have turned the expected surplus in 2012-13 of $3.5 billion into a deficit of $1.4 billion.

So what did Wayne Swan and Penny Wong do about it? Ostensibly, they found savings sufficient to get back to an expected surplus of $1.5 billion. But, as we'll see, it's not that simple.

We've been told repeatedly the announcement involved savings measures worth $11.5 billion over four years. We've been told less often it also involved new measures with a cost to the budget of $4.7 billion over four years.

So the measures' net effect is to improve the budget balance by a much more modest $6.8 billion over four years. Of this, just $2.9 billion relates to next financial year, the year the government's concerns are focused on.

Is $2.9 billion a lot or a little? To you or me it's a king's ransom, more than we'd ever see in 400 lifetimes. But that's not the relevant comparison. Since we're interested in the budget's effect on the economy, it's the size of the economy that's the appropriate comparison.

The nation's annual income (from its production of goods and services, gross domestic product) is about $1.4 trillion ($1400 billion). So $2.9 billion represents a mere 0.2 per cent of our annual income.

You'd thus be justified in concluding that, from a macroeconomic point of view, the measures included with the revised budget estimates on Tuesday weren't worth worrying about. But there are ways of viewing this week's new information that make it seem a much bigger deal.

Consider this. The Reserve Bank's rough-and-ready way of judging the budget's effect on the economy is to look at the direction and size of the change in the budget's underlying cash balance from one financial year to the next.

At the time of the budget in May, the government was expecting a deficit in 2010-11 of $49.4 billion (equivalent to minus 3.6 per cent of gross domestic product) falling to a deficit of $22.6 billion (minus 1.5 per cent) in the present year, 2011-12, and then becoming a surplus of $3.5 billion (plus 0.2 per cent) in the target year, 2012-13.

So, measured against GDP, it was expecting an improvement in the budget balance of 2.1 percentage points this financial year, followed by an improvement of 1.7 percentage points next year.

Now, those proportions of GDP clearly were a big deal. They represented a very rapid reduction of the budget's net support to the economy. So I judged the ''stance'' (setting) of fiscal (budgetary) policy envisaged in the budget to be ''highly contractionary''.

This turnaround in the budget balance was to be brought about by three factors. First, the withdrawal of the earlier fiscal stimulus as its temporary spending came to an end. Second, the effect of the government's ''deficit exit strategy'' of holding the real growth in its spending to no more than 2 per cent a year and granting no further cuts in income tax.

But the third factor was central: the economy's expected strong recovery from the mild recession of 2008-09 would cause faster growth in tax collections and a fall in spending on dole payments. In other words, much of the improvement would come from the operation of the budget's in-built ''automatic stabilisers''.

Right. So how has that picture been changed by the revised forecasts for the economy and the new spending and tax measures announced on Tuesday? The government recorded an actual budget deficit of $47.7 billion (minus 3.4 per cent of GDP) last financial year. It's now expecting a deficit of $37.1 billion (minus 2.5 per cent) this year and a surplus of $1.5 billion (plus 0.1 per cent).

Looking at that the way the Reserve does, the government is now expecting an improvement of 0.9 percentage points (rather than the earlier 2.1 points) this year and 2.6 percentage points (rather than 1.7 points) next year.

Taking those figures at face value, you'd say the stance of fiscal policy was now planned to be much less contractionary this year, but a fair bit more contractionary next.

Some economists have observed that this would involve ''the sharpest improvement in the budget balance for four decades'' and would mean the budget acting as a ''substantial drag on economic growth'' in 2012-13.

Just one small problem. Much of the alleged blowout in this year's deficit and seeming rapid improvement in the budget balance next year arises not from the revised economic forecasts or the substantive spending measures, but from what the government euphemistically refers to as ''reprofiling'' - shifting intended spending and tax measures around between years.

In particular, the government took net spending of roughly $4.8 billion that should have occurred in the target year, 2012-13, and moved it forward to the last two months of this year, 2011-12, thus artificially worsening the comparison of the two years by double that amount, roughly $9.6 billion.

It also improved the target year's budget balance by about $850 million by delaying for a year the start of various tax concessions associated with the mining tax package.)

So, measured the Reserve Bank way, the ''underlying'' stance of fiscal policy remains pretty contractionary in both years - and, after you look through the reprofiling, not greatly changed.

This stance seems appropriate, remembering the economy is close to full employment and monetary policy can be eased (interest rates cut) should that prove necessary.

Farmers fall silent while food brings home the bacon

2011-11-30T09:57:00.000+11:00

Sometimes, as when Sherlock Holmes solved a mystery by noting the dog that didn't bark, the story is not what happened but what didn't happen. If so, don't hold your breath waiting for the media to tell you such a story. Omission is much harder to notice than commission.

But let me ask you - in this year of endless complaint about the supposed two-speed economy - what's been missing? The retailers have been doing it tough and they've let everyone know. The high dollar is great news for consumers - overseas holidays are booming - but bad news for those of our industries that sell on export markets or compete against imports in the local market.

We keep hearing about the difficulties our manufacturers have encountered and, to a lesser extent, the problems facing our tourism industry (see above). Now we're hearing of staff cutbacks in universities because foreign student numbers are down.
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But who haven't we heard from?

A clue - which dog usually barks the house down every time the dollar goes up? Another - which industry contributed to our economy's boom and bust in the mid-1970s by virtually forbidding the McMahon government to revalue our currency in response to a world commodity boom?

That's right, the farmers. So, have they been suffering in silence for once in their lives? Have they, unlike other industries, stoically resisted the temptation to blame all their problems on a Labor government?

No, nothing so worthy. We've heard nothing from the farmers because they've been doing quite well for themselves. And we never hear from farmers when times are good. City slickers never get invited to the harvest festival for fear of undermining the media's stereotype that ''the man on the land'' is ALWAYS doing it tough. In any case, who's interested in GOOD news about the economy?

You can find the story in the official statistics and forecasts, of course, but public officials know always to understate good news about the farm sector for fear of bringing the farmers' ire down on their heads. The few parts of farming that are the exceptions to the rule will declare all you say is lies.

Our farmers export about three-quarters of what they produce. With the exception of wool, the stuff they sell abroad is priced in US dollars. So when the Aussie dollar goes up, the money they earn in US dollars isn't worth as much to them back home.

That's just as true of our miners. They, too, have suffered from the rise in the Aussie. But they're not complaining because the prices they're getting in US dollars have risen by far more than the Aussie has gone up.

It's a similar story for the farmers, though on a much smaller scale. Since the start of the resources boom in early 2003, the prices being received by our miners have risen by 380 per cent in US-dollar terms. Thanks to the Aussie dollar's rise against the greenback, they've risen by a smaller 175 per cent in Australian-dollar terms - which is what the miners care about.

Over the same period, the prices being received by our farmers have risen 90 per cent in US-dollar terms and almost 10 per cent in Australian-dollar terms. (The rise in the Aussie isn't just a matter of bad luck for our miners and farmers. Since our dollar's been floating it has always risen, or fallen, roughly in line with world commodity prices. What these comparisons show is that rising rural commodity prices contributed to the higher dollar, along with rising minerals and energy prices.)

If that was all there was to the story we probably WOULD have heard whingeing from the farmers. But what matters to our farmers even more than what's happening to prices is what the weather's doing to the size of their harvests and other kinds of production. Whatever the price, the world will always take however many tonnes our farmers are able to produce.

And the truth is that, despite exceptions (West Australian wheat for one; the effects of flooding and cyclones), the weather's been a lot kinder to our farmers over the past year or two. It's rained when rain has been needed, there's been more water for irrigation and the moisture content of the soil has improved, allowing more dryland plantings.

This year's winter wheat crop is expected to be a near-record high of about 40 million tonnes and this follows a good harvest last year.

This financial year, our agricultural export earnings are expected to be the second-highest since 2002-03, even after allowing for inflation. Last year's earnings were pretty good, too.

Rises in export earnings are expected for wheat, wool, rice, canola, cotton and lamb, though wine exports continue to languish.

After a bad year in 2009-10, real farm income more than doubled last financial year. This year it's expected to be down only a bit from that.

Why are world agricultural prices so strong? Various reasons, but mainly because of the development of Asia and the steady rise in incomes of its many hundreds of millions of people. As low incomes rise, food consumption tends to increase. And the increase is concentrated in the more expensive types of food.

So food prices are rising for much the same reason minerals and energy prices are rising. And that says they've got a long way further to rise over coming years. Whichever way you look, Australia is sitting pretty in the Asian century. The only shadow over the future of farming comes from climate change and our long mismanagement of water.

Econocrats get smarter on dodgy forecasts

2011-11-28T09:41:00.003+11:00

You've heard the joke that economic forecasters are there to make weather forecasters look good. What you haven't heard is that the nation's top economic forecaster, Glenn Stevens, the governor of the Reserve Bank, thinks the joke "has something going for it".

There's an even older joke: everybody complains about the weather, but no one does anything about it. Actually, nothing we could do would change the weather. But, as Stevens remarked in a speech to the Australian Business Economists last week, some decisions based on economic forecasts can alter what happens (thus making forecasting the economy even harder than forecasting the weather).

That's true of the decisions made by central banks and governments, but it's also true of decisions made by businesses and households - even when their "forecast" is no more sophisticated than a bad feeling or a good feeling about how the economy's travelling and what lies ahead.

Actually, you can't not make a forecast. Even if you refuse to think about the future, you're implicitly making a forecast that things will stay as they are.

The Reserve Bank has no choice but to make the best forecasts it can because it can take two or three years for a change in the official interest rate to have its full effect on the economy. So the Reserve has to act before things get off the rails. Were it to wait until problems actually happened, it would always be acting too late.

But something I've always admired about the Reserve, and Stevens in particular, is their humility and realism on the subject of forecasting.

"It is only natural to desire certainty," he says. "Everyone wants to know what will happen. We all want to believe that someone, somewhere, does know and can tell us what to expect. But the truth is that the best we can do when talking about the future is to speak about likelihoods and possible alternative outcomes."

Like almost everyone else, the Reserve has expressed its forecasts as a "point estimate" - one number. But this gives forecasts an air of precision they don't possess. They're actually a "central forecast" within a range of possibilities.

People (and journalists) who don't understand this can attach too much significance to small changes in forecasts, or to small differences between the Reserve's forecasts and Treasury's. (Tip: they're never going to be very different because they're produced in the same factory, the Joint Economic Forecasting Group.)

Stevens says that "when consideration is given to the real margin for error around central forecasts, such differences are often, for practical purposes, insignificant". "When comparing forecasts, if we are not talking about differences of at least 0.5 percentage points, the argument is not worth having."

Consider this. In the case of a year-ended forecast for the growth of real gross domestic product four quarters ahead, the record over the past couple of decades says the probability of a point forecast being accurate to within 0.5 percentage points is about 20 per cent.

Experience since the start of inflation targeting in 1993 says the probability of underlying inflation over the next year or the next two years being within 0.5 percentage points of the central forecast is about 67 per cent. That is, if the forecast was 2.5 per cent, the chances of the outcome being between 2 and 3 per cent would be about 67 per cent.

"So any point forecast will very likely not be right," Stevens says.

According to Stevens, it would be vastly preferable for discussions of forecasts to be couched in more "probabilistic" language than tends to be the case, and for there to be more explicit recognition that the particular numbers quoted are conditional on various assumptions. To this end, the revised forecasts the Reserve published earlier this month, particularly those for the year to December 2013 (that is, more than two years away), were expressed as a 0.5 percentage point or even 1 percentage point range. Now you know why.

And, Stevens adds, the forecasts include "more extensive discussion these days of the ways in which things could turn out differently from the central forecast". "This goes at least some way to recognising the inherent uncertainties in the forecasting process, and is also important in relating the forecast to the policy decision."

But if forecasts are so dodgy, why bother? Why not merely assume things don't change, since that at least would be quicker and cheaper? Stevens insists economists can shed useful light on the future.

"We know something about average rates of growth through time," he says. That is, forecasts that the economy will return to its trend rate of growth are likely to be closer to the truth than forecasts that it will stay at the rate it is now.

Stevens says economists also know something about the long-run forces that produce economic growth: productivity and population growth. "We know that there have been, and will be again, periods of recession and recovery, though our ability to forecast the timing of those episodes is limited," he says.

"We know from experience some things about the nature of inflation, including its characteristic persistence, and the things that can push it up or down." But above all, Stevens says, we know some of the "big forces" working on the global and local economies at any time. The two big (and conflicting) forces at present are the resources boom and the troubles of the euro.

A lot of the work of forecasting boils down to weighing up the net effect of the conflicting big forces at the time. We'd be better off debating and understanding the effects of those forces than arguing about point estimates.

Why economists are obsessed by the resources boom

2011-11-26T08:47:00.003+11:00

The world is throwing two big things at our economy. One is new, exciting, even frightening, and is getting all the headlines. The other is old news and getting boring. But get this: the boring one is by far the more important.

The new and exciting story is the increasingly worrying developments in the euro area. The old story is the resources boom. Both come to us from the rest of the world. In terms of their effect on our economic growth, the resources boom is a huge stimulus, whereas Europe's problems are a drag on our growth. That drag is small so far but, if the worst comes to the worst, could be a big negative.

Another reason the commodity boom is less exciting is that we've had plenty of them before over our history. But one reason we shouldn't underestimate the boom is that, paradoxically, previous booms have really stuffed up our economy. And these booms can be great for some parts of the economy while making life really tough for other parts.

This week Treasury's Dr David Gruen gave a speech to the Australian Business Economists in which he compared this commodity boom with the one we had in the early 1970s. It helps you see why the econocrats who manage our economy are positively obsessed by the need to make sure we don't stuff this one up.

In contrast to this one, the commodities boom of the early '70s involved big rises in the prices we were getting for our agricultural exports. It got going under the McMahon Coalition government and continued under the Whitlam Labor government.

Comparing the two booms, after the first three years our terms of trade - the prices we receive for our exports compared with the prices we pay for our imports - had improved by about the same extent. In the '70s, they then fell back. This time, however, they continued improving to now be almost 50 per cent better than their best then.

So this boom is a mighty lot bigger - Gruen calls it a ''once-in-a-lifetime boom'' - and a lot longer. This one's been building for eight years (with a brief interruption by the global financial crisis), whereas the earlier one lasted only about three years. The reason this boom is much bigger and longer is that it arises from a historic shift in the structure of the world economy - the industrialisation of Asia - whereas the '70s boom arose merely from an upswing in the rich countries' business cycle.

The greater size and length of this commodity boom has two important implications. First, it's given our miners both the incentive and the time to invest in hugely increasing their capacity to export coal, iron ore and now natural gas. That didn't happen with farmers in the '70s. This present investment boom has added an extra dimension to this boom, thus causing its effect on the economy to be bigger.

Second, the '70s boom was too small and short to have much effect on the industry structure of our economy. But this boom will leave us with a much bigger mining and mining-related sector, thus reducing the relative size of other sectors and putting a lot of pressure to adjust on some industries, particularly manufacturing, tourism and education. It's actually changing our economy's ''comparative advantage'' (what we're good at relative to other countries).

Naturally enough, both commodity booms caused the economy to grow faster. But in the '70s growth was a lot more variable. Real gross domestic product grew almost 9 per cent over the year to March 1973, but by 1975 the economy was contracting. It recovered, then contracted again in 1977. Unemployment, which had been very low for many years, shot up and stayed up. This time, growth has been strong but steady and unemployment has fallen and then stayed pretty low.

In the '70s, the inflation rate took off, reaching a peak of 17 per cent in the mid-1970s and staying pretty high until the mid-1990s. Obviously, the '70s commodities boom can't take all the blame for this long period of economic malfunctioning. But it should get a fair bit, and it certainly got the rot off to a good start.

There's one other big difference between the two booms that does a lot to explain why this boom hasn't caused nearly as much volatility, inflation and unemployment as the first one did: the exchange rate.

The present boom quickly brought about a rise in the value of our dollar. Since June 2002 it has risen by about 45 per cent against the trade-weighted index. In the '70s, the rise didn't happen nearly as quickly or smoothly.

Why not? Because then we had a fixed exchange rate. It could be changed only by a government decision. For political reasons, the two governments waited too long and didn't do enough to get the dollar up.

The point is that our floating currency acts as a shock-absorber when the economy is hit by some shock - favourable or unfavourable - from abroad. In this boom, the higher dollar has caused the Australian-dollar income of the miners to rise by less than it would have, and has effectively handed that reduction in their income to all the other industries and individuals who buy imports. How's it done that? By making imports cheaper.

By transferring income from the miners to the non-miners, the high dollar has helped ensure the rest of Australia gets its cut from the boom, but it's also reduced the size of the commodity boom's effect on the growth in gross domestic product by directing a fair bit of the increased demand into imports. This has caused the boom to generate less inflation pressure, as well as directly reducing the prices of imported goods and services.

So it's clear the present boom has had far more benign effects on the economy than the '70s one did. Our economic managers get a lot of the credit for that, but much credit is due simply to our floating exchange rate.

Gruen concludes, ''if a sizeable boom is being generated in one part of the economy, significant restraint needs to be imposed on other parts to ensure that the economy overall does not overheat''. See what he's saying? Yes, you're right, there is a multi-speed economy and manufacturers and service exporters are doing it tough. But that's not happening by unhappy accident, it's happening by design. Live with it.

Outlook for politics and government in 2012

2011-11-24T14:06:00.009+11:00

Talk to Australian Business Economists Annual Forecasting Conference
Sydney, November 24, 2011

Taken as a whole, the first full year of the Gillard government has been terrible. Julia Gillard has hardly taken a trick all year and her present standing in the polls is worse - much worse, consistently worse - than it was at last year’s election, when she failed to attract enough votes to form government in her own right. Her present primary vote in the low 30s would give her zero hope of winning an election. Only if she could get it up to at least 40 per cent would she be in the hunt. This time last year - three years out from the next election, assuming the government runs full term - I fearlessly predicted Labor would lose it, because ‘this generation of Labor is terminally incompetent’.
Having made that call, I’m sticking to it. I’m doing so even though I know full well how easily the political outlook can change over a period as long as a year, let alone two years. After all, who would have predicted in October 2009 that the election would be months early and fought not between Kevin Rudd and Malcolm Turnbull, but between Gillard and Tony Abbott, that Abbott would come within a whisker of winning and that Labor would be forced into an alliance with the Greens and rag-tag independents?

But I have to add that, at the end of her first year, Gillard and her government are looking in better shape than they did half way through it. The first point to acknowledge is that she’s held her minority government and its alliances together for a year - longer than many people expected - and it’s never seriously looked in trouble. The second is that it’s been a year of great achievement. The opposition has frequently criticised Labor for being unable to actually do anything but, as was always Gillard’s intention, this has been a year of ticking off items on the to-do list - in particular, the various items inherited from Rudd. Of the three big problems he left her, the carbon tax has been put to bed, the mining tax is well on the way and only the asylum-seeker issue remains chronically unresolved. Along with Gillard’s opportunity to be seen looking like a leader on the international stage with other leaders, these runs on the board do much to explain her recent slow improvement in the polls, in the two-party preferred and, particularly, as preferred prime minister.

While the polls continue moving in the right direction - however slowly and with however far to go - Rudd is unlikely to mount a challenge. There’s no reason to doubt his desire to return, and should the poll recovery falter, we’re likely to hear from him. Would the caucus ever turn back to him? There is so much continuing dislike of him they’d have to be terribly desperate, but it’s not impossible. Would it help? No. His grass-is-greener popularity in the polls would soon evaporate as voters were repulsed by this ultimate proof of Labor’s disloyalty, ruthlessness and lack of principle.

Next year should be a year of consolidation and less frenetic policy making, with the government needing to be sure the introduction of the carbon price arrangements goes smoothly. Should the world economy stay on track, the government will press on with its priority of returning the budget to surplus - as, in all the circumstances, it should. Should things go really bad in Europe, the primary response will be from the Reserve Bank, but the government will at least have to reverse its rhetoric and allow the budget’s automatic stabilisers to widen the budget deficit, and may need to consider a new round of fiscal stimulus. For Abbott and the opposition it will need to be a year where, finally, they make their contribution more constructive, outlining their own plans for improvement - even if, as ever, they leave the revelation of their detailed policies until much closer to the election. The longer Abbott continues with his relentless negativity, the more he risks trying the patience of voters.

Can we be sure the minority government arrangement will hold together for another year? No. But the grubby deal to install the former-Liberal Peter Slipper as speaker means it now would take two by-election losses to bring Labor undone. It also reduces Labor’s dependence on any particular independent. And by now it ought to be clear to all that the independents on whose votes Gillard relies have much to gain by continuing to prop her up and much to lose by deserting her. It should also be clear that achieving continued co-operation from the people whose votes she needs is one of the things Gillard is good at.

Why Labor is so bad at it

I have no problem putting the boot into politicians who are flying high, but I don’t enjoy kicking people when they’re down. If for no other reason than that I prefer to be ahead of the conventional wisdom. But I can’t take a look at the political scene and not address the obvious challenge for political analysts: why exactly is this version of Labor so bad at governing?

A host of explanations has been offered, many of which have only some degree of truth and some of which are more in the nature of excuses. One we can dispense with is that it’s all down to the personal failings of Rudd. He had many failings and he left Gillard with a terrible inheritance of a far too long agenda of half-finished policy projects, but we’ve seen enough to know things didn’t immediately look up after his departure.

A favourite excuse of Labor and its supporters is that it’s been turned on by the Murdoch press. It’s true The Australian has turned from being a newspaper to a product aimed at gratifying the prejudices of a particular segment of the audience, but it is - by commercial design - preaching to the already converted. Its influence is limited to those silly people in Canberra who continue to take it seriously, imagining it still to be a newspaper. As for the depredations of Sydney’s Daily Telegraph, it was ever thus. That organ has been a vehicle for foisting the bosses’ views on workers since it was owned by Frank Packer. It’s true the radio shock jocks often take their line from those two outlets, but were they not available the jocks would just have to work harder to find their sources of daily indignation. So, sorry, but I think the Murdoch excuse is greatly overdone. It falls into a class of argument politicians trot out to sustain the faith of the party faithful, not because they believe it or expect the uncommitted to believe it.

I think part of the problem attaches to Gillard herself. The brutal circumstances in which she came to power count against her in the mind of many voters. I don’t doubt there’s an element of misogyny in the electorate’s failure to warm to her and that many people find her voice grates. But her deeper problem is her inability to come over on television as a warm and likable person. Some pollies have that ability, others don’t. Other politicians manage to substitute an air of paternal authority - don’t worry, father is in charge - for likeability (eg Malcolm Fraser, Maggie Thatcher), but Gillard can’t manage that, either.

Lack of an air of authority - leaders who look like leaders and hence command respect and compliance; leaders who seem legitimate - has plagued the Rudd-Gillard government. I’ve come to the conclusion that - at the federal level, at least - the Liberals really are the natural party of government. That’s what the electorate thinks, what business thinks, what the media think, what the Libs themselves think and what, deep down, even Labor thinks. On the central polling question of which party is best to handle the economy, the Libs always win. The Hawke-Keating government managed to out-poll the Libs for a while, but Rudd and Gillard never have. This is not a question of track record, but of long-held and deeply held stereotypes. The party of the bosses will always be better at managing the economy than the party of the workers.

This is what allows Abbott to turn opposition to outright obstruction without attracting criticism. It’s what allows Abbott to take the support of business for granted, while Labor knows it must always be seeking business’s approval. It’s what has allowed business to conclude Labor is anti-business even while Labor modifies its policies - including Fair Work - to avoid offending business. It’s what, in the battle over the mining tax before Rudd’s overthrow, allowed the public to believe the foreign mining giants’ ads claiming the tax would destroy the economy over their own government’s ads assuring them the tax wouldn’t be a problem.

It’s what explains the Libs’ ability to wind up the electorate over Labor’s mountainous deficits and debt and why few economists intervened to dispel the nonsense. It explains why the opposition has had an excessive influence over the government’s fiscal policy and why Labor is obsessed by returning the budget to surplus in 2012-13. It also explains why only at this point have economists entered the debate to attack the government’s deficit mania.

Labor’s universally assumed inferiority - combined with journalism’s highly selective approach to quoting evidence - explains the success of The Australian in convincing almost everyone - punters, gallery journalists and even Labor politicians - that most of the money spent on Building the Education Revolution was wasted.

Associated with Labor’s lack of apparent authority is the phenomenon of the slippery slope. When you’re in power and on top you get a lot of co-operation, compliance and tacit support from interest groups and the public generally - all of which help you stay on top. These benefits of incumbency give you the strength to stand up to particular vested interests and tide you through the ups and downs of the polls. But when your weakness in the polls becomes sustained, you hit the slippery-slope part of the curve where it becomes a lot easier to fall further than to claw your way back up. Where things start to unravel as people who formerly accepted the reality of your continuing authority begin to wonder how long you’ll survive, whether they should give you a push on your way and whether they should start cosying up to your likely vanquisher.

Though she seems to have made a little progress back up the greasy pole in recent days, Gillard has spent most of her time as PM sliding down the slippery slope. It’s a situation that emboldens your critics and opponents while making your supporters more cautious. So things have been unravelling. The denizens of the House with the Flag on Top - pollies on both sides, staffers and journalists - revere success, fear the successful and despise failure. Lindsay Tanner says the press gallery is either at your feet or at your throat. It shifts when it sees you languishing in the polls, emboldened to be a lot more probing and critical and take a lot less on trust. The denizens take the polls so seriously that everyone starts expecting anything you do will fail, and their expectations tend to be self-fulfilling.

One interest group that’s particularly susceptible to this behaviour is business. Business will live with a housetrained Labor government with a steady grip on power. But it does so against its natural preferences. Big business people expect Labor to court them, while quietly accepting it when the Libs choose to ignore or pressure them. Business is very unhappy with Labor and I have no doubt its disenchantment and its increasing willingness to make its unhappiness known is magnified by its perception the Gillard government is not long for this world. It’s willingness to accept the carbon tax has been diminished by Abbott’s success in turning public opinion against the tax. Its complaints against Fair Work - which don’t seem to have great substance - are directed mainly at persuading the next government to shift the balance back in favour of employers. If this does collateral damage to Labor between now and the election, so much the better.

Both the Rudd and Gillard governments seem remarkably inexperienced. This shouldn’t be an excuse because it’s unusual for incoming federal cabinets to have many members with previous ministerial experience. Labor doesn’t seem to realise that maintaining good relations with business isn’t just a matter of senior ministers trying to fit in as many boardroom lunches as possible, or even keeping in touch with the business lobby groups. It means having big business chiefs feel they can ring the PM about a problem and their being on the receiving end of calls from the PM to inquire about their views on relevant matters. The main union leaders would have such a relationship with the PM, but I doubt the business chiefs do. They’d know this and would feel alienated from Labor, especially because Howard was such a great private phoner of power-holders.

Similarly, Labor’s failure to make sure the big miners knew what to expect well before the unveiling of the resource super profits tax is a sign of inexperience. The name of that tax - chosen by Labor’s spin doctors - did much to convince the rest of the business community Labor was anti-profit and anti-business, without doing much to arouse the punters’ resentment of foreign mining giants. Labor’s PR people have been far too young, lacking much journalistic experience, let alone political experience. It should have recruited some old hands. Rudd treated his staff so badly he burnt through a generation of good advisers.

But Labor’s chronic inability to sell its policies to the electorate can’t be explained simply in terms of the inexperience of its spin doctors. It isn’t primarily about spin doctors. I think the root of this generation of Labor politicians’ problem - the key reason they’re so bad at governing - is their background. Unlike earlier generations, almost all of them are apparatchiks; they come from Labor’s professional political class: people who start working for ministers or unions straight from university and climb the Labor career path, never making a success of a career in the outside world or even spending a lot of time as an on-the-ground union official dealing with ordinary workers and disparate employers.

The trouble with this system is that it seems to be breeding a generation of politicians who don’t have a good feel for human nature and, above all, don’t give up their profession and enter parliament with a burning desire to make the world a better place. Their burning desire is to make cabinet minister. Their entry to parliament is a promotion and a pay rise, not any sacrifice. These guys don’t have deeply held values and convictions they’re prepared to fight for and run risks for. Their lack of conviction robs them of the ability to explain policies that arise from their framework of belief. They can’t fashion a compelling narrative of what drives them and where the government wants to take us. They lack the missionary zeal of someone like Paul Keating; they have no desire to convert. They think ‘selling’ policies is a matter for spin doctors and advertising agencies, not of working tirelessly to help people understand the vision and see why it’s so important. When you’re not passionate about explaining your policies, when you’re just a political player, you do what Labor has done from the moment it took office: focus on attacking your opponents, thus conferring them and their criticisms a status they wouldn’t otherwise have. When you’re not a passionate explainer, you avoid answering questions and merely repeat prepared lines.

The problem with all this isn’t just that you fail win public support for your policies, it’s also that the public can sense your lack of commitment and conviction, your preference for self-preservation over leadership, your interests over theirs. You lose authority and respect in the eyes of voters. Courage comes from convictions; public confidence in governments comes from people’s perceptions of your courage and conviction. As John Howard demonstrated with the GST, voters are perfectly capable of giving you grudging respect for pursuing a policy they don’t like the sound of.

Minority government may be the making of Gillard

But having said all that, I now have to highlight a qualification. At the end of its fourth year, Labor has now amassed an impressive list of achievements. Leaving aside its remarkably effective response to the global financial crisis, we have: paid parental leave, equal pay for community workers, plain packaging for cigarettes, the foundations for a national disability insurance scheme, a price on carbon, the likely passage of the minerals resource rent tax, and the continuing pursuit of compulsory pre-commitment on poker machines. (Admittedly, the mining tax was butchered and Labor’s health and hospital changes fell far short of their billing.)

Some of the items on that list may not greatly appeal to you, but they would to the Labor heartland. And it’s noteworthy that some of the items wouldn’t have been there had it not been for the insistence of those whose votes Labor has depended on to stay in government. On the carbon price, in particularly, Gillard had no choice but to press on with its early introduction. See what’s happened? The circumstances of minority government and the ferocious opposition of Abbott have left Gillard with no option but to take principled positions and stick to them through thick and thin. If her improvement in the polls proves lasting, it will be because her failure to win a majority has forced her to exhibit all the impressive qualities she seemed not to possess. Her steadfastness and ultimate achievement may be winning her the grudging respect of the electorate.

Provided she can hold the numbers in the House for another two years, Gillard should benefit from the effluxion of time. It will give people more time to get used to her idiosyncrasies and more time to tire of Abbott’s. And there’d be something very wrong if more than a year of living under the carbon tax didn’t cause people to lose their fear of it.

It’s interesting to observe the way conservatives have transferred the mantle of bogyman from the ALP to the Greens. Labor’s greatest crime is not being typically wrongheaded Labor, but falling under the spell of the demonic Greens. Exhibit A would have to be the carbon scheme. But, apart from its higher levels of compensation to industry, it was little different from Rudd’s carbon pollution reduction scheme, which the Greens rejected out of hand. It’s not politic to say so but, in the end, it was the Greens who changed their tune, much more than Labor did.

The prospect of Abbott

Abbott has been far more effective as opposition leader than I and other smarties expected. He quickly learnt to keep disciplined and avoid putting his foot in his mouth, and quickly displayed his greatest, most enviable strength as a politician: an ability to ‘cut through’ - to have the things he says noticed and broadcast by the media.

His policy of blanket opposition to all the government’s policies has served him well. Many expected the electorate to tire of his relentless negativity, but it hasn’t happened yet. Even so, some strains are beginning to show. His autocratic style has put noses out of joint within the party and, should his standing in the polls ever slip, we will hear from his detractors. There is much discontent within the party and in business over his refusal to criticise Fair Work and propose any changes that could reawaken the spectre of Work Choices.

Despite the opposition’s remarkably strong standing in the polls, Abbott is not personally popular. He has a 55 per cent disapproval rating for his job as opposition leader. And the authoritative Australian Election Study, in which ANU political scientists surveyed voters soon after the last election, found that Abbott’s unpopularity was the main reason he failed to win enough seats. Though Gillard’s popularity rating was low, Abbott’s was a lot lower - lower even than Keating’s in the 1996 election.

Abbott has little interest in economics and no commitment to economic rationalism. His policy positions reek of populism, protection and direct controls. His solemn promises to roll back the carbon and mining taxes, but not reverse the goodies they will be paying for, leave him with a funding gap of many tens of billions he has, as yet, made no attempt to fill. How such a man could bring himself to outline the sweeping spending cuts needed to make good his promise to return the budget to surplus without delay is hard to imagine. He has, however, taken the precaution of refusing to use the services of the new Parliamentary Budget Office to cost his promises. There is no precedent for parties promising to abolish major new taxes already in operation, nor for governments actually doing it. I find it very hard to believe it would happen.

Should Abbott be elected, we face either a monumental breaking of promises or a government totally consumed by the effort needed to turn back the clock. Why the part of the electorate that cares most about good macro management and micro reform has had so little to say about Abbott’s incredible performance I don’t know. Perhaps they’ll have more to say as the reality of an Abbott-led government draws closer.

Observations on monetary policy

I normally begin this section by observing that the market and the business economists have had another bad year in their efforts the second-guess the Reserve Bank’s moves in the cash rate, but this year I have to declare the second-guessers to be ahead on points. The notion that the Reserve might cut rates entered the futures market’s head a lot earlier than it entered the Reserve’s head, so the market has to get credit for that. I’m not sure the market was particularly prescient on size and timing - suggesting it might have been right for the wrong reason. I suspect the market was dominated by foreign players who merely projected North Atlantic conditions onto the Antipodes, making insufficient allowance for local conditions. But, as all of us in the prediction business know full well, a win’s a win. I wouldn’t make those criticisms of the other great hero of this episode, Bill Evans. He stuck his neck out ahead of all of us, we marvelled at his folly, but he turned out to be right and he deserves all the accolades he got.

From where I sit it’s clear to me that to make a legendary call like Bill’s you have to get well ahead of the game, well ahead of the data - and you have to be right. When I saw Bill make his call I thought, that’s not in the Reserve’s plan, so he’ll only be right if he foresees developments the Reserve doesn’t foresee and those developments are big enough to change the plan. He did and they were.

The Reserve begins each year with a view of how the year’s going to pan out and a rough idea of the policy adjustments the outworking of that view will necessitate. It must have such a view because it has an on-the-record forecast, and that forecast is its view. The trick for you guys is to work out what its forecast tells you about the policy adjustments needed to bring the inflation forecast about, given the growth forecast.

This year the Reserve was expecting growth to accelerate as the effects of the resources boom spread through the economy, adding to inflation pressures at a time when we were already close to full employment. It was therefore expecting to have to tighten a few times as the year progressed. But here’s the point: it’s continuously testing its forecasts and its expectations against the data as they roll in. And it makes its judgments about whether policy needs to be adjusted one board meeting at a time. As events unfolded, the economy didn’t accelerate in the way it had been expecting, and so the Reserve never reached a point where it saw the need to act on its ‘bias to tighten’. At first there was the temporary setback of the Queensland floods - which proved less temporary than first thought - and then there was the backwash from the growing sovereign debt problems in Europe, mainly on business and consumer confidence. By November it was clear the economy wasn’t taking off the way the Reserve had expected - mainly because of the confidence backwash from Europe - so the Reserve wasn’t going to have the trouble keeping inflation within the target range it had expected to have, thus allowing it to make what it expects to be a once-off reduction in the cash rate to get it back to neutral. It’s worth noting that part of the scope for this move came not from the effects of Europe but from the past and future revisions to the underlying inflation figures arising from the Bureau’s reweighting of the index.

I don’t think the Reserve has very firm ideas about where the stance of policy goes from here. The economy is pretty much in equilibrium, policy is set at neutral, so the rate will stay where it is until developments occur that knock the economy off its equilibrium path - and off the Reserve’s forecast - in one direction or the other and require a policy response. Clearly, the balance of risks is very much to the downside.

But Bill has made another call and, as I understand it, is predicting another three cuts -presumably 25-basis-point cuts - next year. Here again you see him getting well ahead of the game; well ahead of the Reserve’s thinking, as expressed in its forecast. He can see something coming down the pike the econocrats can’t, and he may again prove himself to be more prescient than them. What would fit Bill’s call of three further cuts over the course of 2012 would be for the economy to slow down rather than speed up as forecast - for it to run out of gas, presumably because of growing caution and uncertainty on the part of business and consumers in response to continued turmoil in Europe. This would be manifest in a continuing rise in unemployment and an inflation outlook that was even more benign, thus allowing the rate to be lowered another click. Of course, were Europe to turn into the full catastrophe, we all know from the events of late 2008 how the Reserve would react. In that case I wouldn’t be surprised to see three cuts next year, but they’d probably come thick and fast, and each be nearer 100 points than 25.

I remarked in my column last Saturday that when the news is full of stories about some economic issue and the authorities pop with a policy change, all the instincts of the media and the punters are to assume that A caused B. In this case, we hear all this bad stuff from Europe, which makes us think the European economy is stuffed, therefore we must be stuffed and that must be what caused the Reserve to slash its forecast and cut the rate. I think all humans have a tendency to string together chains of cause and effect in this way and for our thinking to be unduly influenced by those events that have ‘salience’ (prominence in our consciousness) because they are so dramatic, so highly publicised or so recent.

My point is that this defective reasoning may be very human, but economists need to do better. Because the markets and business economists spend so much time studying developments overseas - usually the US, but these days, Europe - and they do that because national financial markets are so highly integrated - these developments have great salience in their minds, which can tempt business economists to over-weight them when forming views about likely developments in our economy - our real economy.

We need to remember that overseas events may be very exciting and very important, but they’re only relevant to us, our forecasts and our policy stance to the extent that, by some clearly identified channel, they have an effect on our real economy. They may be big in Europe, but are they still big by the time they reach us? Our real economy isn’t nearly as well integrated with the world as our financial markets are. Our domestic demand (GNE) accounts for almost all of our aggregate demand, sometimes more than all. As I keep reminding my readers, roughly 80 per cent of what Australians produce they sell to other Australians and roughly 80 per cent of what they purchase they buy from other Australians. Of course, the sharemarket is a more important channel than it used to be, and so - thanks to an ever-more globally integrated media - are confidence effects. I say all this simply because I keep hearing business economists making predictions about what the Reserve will do, and explaining why it’s done what it’s done, much more in terms of overseas development than I see in all the Reserve’s detailed exposition of why it did what it did. You’ve got to get your direction of causation right. The Reserve is managing our economy, it’s responsible for our inflation rate. Its highest consideration will be what’s happening in our economy and its interest in what’s happening in other people’s economies is limited to assessing the extent to which those events impinge on our economy. That’s obvious, but people who know a lot about what’s happening in other economies seem to keep forgetting it. Sometimes I think the traditional order in which the econocrats set out their analysis - start with the world, then move on to the domestic - may confuse people as to which is the more important.

Last year I advanced my theory that the timing of rate changes is influenced by ‘bureaucratic neatness’. At the time I said:

"Over the past five years the Reserve has changed rates 20 times. Since there are 11 meetings a year, if decisions to change rates occurred at random, each month would have a 9 per cent chance of being chosen for a rate change. The four meetings a year that are preceded by the release of the CPI and followed immediately by the release of the statement on monetary policy, would account for just over 36 per cent of random chances. But, in fact, the SoMP months - February, May, August and November - accounted for 65 per cent of rate changes, with November alone accounting for 25 per cent. The point is that the Reserve has set up a pattern in which the SoMPs come soon after the meeting that comes soon after the CPI release, and two of the SoMPs come not long before the Reserve’s twice-yearly appearance before the parliamentary committee. Remember, too, that the release of the CPI is a key influence on the revision of the Reserve’s inflation forecasts, which are published in the SoMP and which heavily influence decisions about rate changes. The SoMP serves as the main vehicle the Reserve uses to explain and defend its rate decisions. Is it surprising that, having carefully set up the timing of its key publication and parliamentary appearances, the Reserve is more inclined to fit its decisions into that timetable? But why in the past five years has the November pre-SoMP meeting had more than twice the hits that the other three pre-SoMP meetings have had? Perhaps because of an unconscious desire to get the books straight before the end of the year and the knowledge that what you’ve done has to tide the economy over until February."

That was a year ago. What’s happened since then? We’ve had just one rate move and it happened on . . . Melbourne Cup Day, making it the sixth cup day move in a row. Still think it’s mere coincidence? Last year when I advanced my crazy, utterly economics-free theory, my mate Rory Robertson was the first to express his scepticism. So I asked some relevant econocrats what they thought of it. They thought it had some validity. Provided the Reserve hasn’t got behind the curve, and thus needs to catch up ASAP, it will be more inclined to move in those months that fit its carefully constructed reporting cycle.

Facts count, because what's mined is yours

2011-11-23T22:53:00.001+11:00

By far the biggest development in the economy in recent years is the mining boom, and it's likely to roll on for at least the rest of this decade. But Australians are having a lot of trouble getting their minds around the boom's implications. The area abounds with worries and misperceptions.

Economists keep banging on about the mining boom because it's the biggest factor driving the economy's growth. We've had a surge in export income because the world is paying such high prices for our coal and iron ore. And we're also getting huge spending on the construction of new mines and natural gas facilities.

The other reason economists get so excited about the topic is that this is hardly the first commodities boom Australia has experienced (the first was the gold rush) and most of our previous booms have ended in tears. We've quickly spent all the extra money coming our way, but that's led to rapidly rising prices. The authorities' efforts to stamp out inflation have ended up causing a recession and rising unemployment.

The present managers of the economy are determined to ensure that doesn't happen this time by keeping spending and inflation under control. This explains why, until recently, the Reserve Bank was always thinking about putting up interest rates, and why the Gillard government has been so keen to get its budget back into surplus.

But all the fuss people like me have been making about the boom has left many Australians with a quite exaggerated impression of the size of our mining sector. According to a poll conducted by the Australia Institute, on average people imagine mining accounts for 35 per cent of the goods and services the nation produces (gross domestic product).

But while mining's share of national production has increased significantly in recent years, it's still up to only 10 per cent.

Many of us see the main pay-off from an expanding industry as all the jobs it generates. So what proportion of the workforce is employed in mining? According to the Australia Institute's polling, our average answer is 16 per cent.

The truth? Even after all that expansion, less than 2 per cent. How could an industry responsible for 10 per cent of our production account for just 2 per cent of employment? By being intensely ''capital-intensive'' - by using a lot of machines and not many workers.

So, does that mean mining isn't really worth all the fuss? A lot of its industrial rivals will tell you so, but it ain't true. The true test of the worth of an industry is not how many people it employs but how much income it generates. And, particularly at present, mining is generating huge income. Do you realise it accounts for more than half the nation's export income?

The reason income trumps employment is that as income is spent it generates jobs. When you spend a dollar it percolates through the economy, supporting and creating jobs as it goes. So if mining creates 10 per cent of national income but only 2 per cent of national employment directly, that just means it supports another 8 per cent of national employment indirectly, in other (labour-intensive) industries.

Which other industries? For the most part, service industries. How can I be sure? Because after you allow for the 2 per cent of Australians employed in mining, the 3 per cent in agriculture and the 9 per cent in manufacturing, the remaining 86 per cent are employed in the many service industries: wholesaling and retailing (15 per cent), healthcare (11 per cent), construction (9 per cent), education and training (8 per cent), the professions (8 per cent), hospitality (7 per cent), public administration (6 per cent), financial and business services (6 per cent), transport (5 per cent) and many more.

Another reason I can be sure most of the jobs created indirectly by mining are in the services sector is that, for at least the past 40 years, all the net increase in national employment has come from the services sector.
Am I touching a nerve here? A lot of people are uncomfortable about the mining boom because they see it as temporary and they see digging stuff out of the ground as a pretty unsophisticated way to make a living. What do we do when it's over and what else do we do to make a buck?

It's true the sky-high prices we're getting at present won't last, but nor will they crash back to what we used to get. And we'll have a much bigger mining industry selling a lot more of the stuff than we used to. They may be non-renewable resources, but we've got a mighty lot of 'em.

What else can we do? What most of us have always done: sell services to one another and to foreigners. In these days of the information and communication revolution, most of the highly skilled, highly paid jobs are in the services sector. Those who find this intangibility discomforting are hankering after a bygone century.

It is true, however, that we must ensure we end up with something to show for this boom and that too much of the huge profit being made doesn't just end up in the hands of the mining industry's owners (about 80 per cent of whom are foreign). After all, the minerals they're mining are owned by all Australians, not the miners.

That's why it's good to see Julia Gillard's profit-based mining tax finally being passed by the House of Representatives, even though Tony Abbott's mindless opposition to it allowed the three big foreign mining companies to butcher the tax.

Internet commerce will foster price competition

2011-11-21T07:24:00.000+11:00

The critics of economists often accuse them of trying to change the world to make it more like their textbooks. But now the mountain is coming to Muhammad. The internet, and the electronic commerce it promotes, is making real-life markets work more the way economists assume they do.

As the retailers - particularly the department stores - have sought to explain the weak growth in their sales, their gaze has fallen on the internet. The high dollar has made it more attractive for people to buy stuff on the net from overseas sites. And people who buy from foreign sites don't have to pay goods and services tax on purchases of less than $1000.

As an explanation for their weak sales, it's not persuasive. The share of consumer spending accounted for by internet purchases is still quite small. The more likely explanation is simply a shift in consumer preferences from goods to services.

But internet purchases will become a significant competitive challenge to retailers as people get more experienced at and relaxed about internet shopping. (And as Australia Post gets better at delivering parcels to households without a stay-at-home spouse.)

It's a mistake, however, to imagine it's primarily the high dollar that will drive this trend (or that the presence or absence of a 10 per cent GST makes much difference). No, the primary source of internet bargains is the existence of what economists call ''price discrimination'': the longstanding practice of international suppliers charging higher prices in some markets than others.

Global firms selling books, music, DVDs, software, sneakers and much else know the punters' ''willingness to pay'' varies greatly between countries. Why? Because, for instance, Aussies are simply used to paying higher prices than Americans are.

Such price discrimination is a great way to maximise profits - provided you can keep the various markets separate and stop people in high-price markets switching their purchases to low-price markets.

Various global industries have long used legislated restrictions on ''parallel imports'' to protect their price discrimination arrangements - against which economic rationalists have long fought mainly losing battles. But all that legal protection is being swept away as the internet provides us with direct and easy access to cheaper American goods. This will put a lot of pressure on Australian retailers (and their foreign suppliers and landlords) to lower their prices.

Cyberspace breaks down the natural protection provided by oceans and geographic distance (although, of course, this becomes less true as the bulkiness of the goods in question increases, making transportation over long distances uneconomic).

So it breaks down barriers between certain geographic markets and also breaks down barriers to firms entering a particular market. If you're a big, established player in a physical market, it's very hard for me to start up in competition with you and get myself noticed. In cyberspace, however, a web browser that finds your huge site will list my bedroom operation beside it. It takes the punter only a few clicks to check me out after he's checked you out. Since I don't have the brand recognition you have, my price may well be 5 or 10 per cent lower. I can't charge a premium for my established reputation for quality and reliability.

In its basic form, the economists' model assumes there's no cost in money or time to gather all the information you need to be a fully informed buyer or seller in a market. In reality, there's often a lot of cost involved.

So much so that the possession of information is often ''asymmetric'' - the seller knows a lot more about what's what than the buyer does. This asymmetry tends to favour (professional) business over (amateur) punters (except in the labour market, where a worker knows far more about their personal strengths and weaknesses than a potential employer does).

Clearly, the internet greatly reduces the cost of gathering information so as to make better-informed decisions. This should reduce the asymmetry of information, thus shifting reality closer to the model.

The economists' model focuses on price - the price of the item in question relative to other prices - as the key to how markets work. It assumes relative prices (''incentives'') are the only motivator and that all competition is price competition.

In reality, oligopolies much prefer non-price competition via advertising, marketing (such as the nature of the packaging) and merchandising (where and how you display items in your store).

On the internet, many of these non-price devices are a lot less ''salient'' (prominent), thus making prices more salient. And the internet is a lot better at gathering and comparing price information than information about qualitative considerations.

According to a psychology experiment, when people face a choice between an interesting job paying $80,000 a year and a boring job paying $90,000, most choose the boring one. That's not because they're money-hungry, but because of the limits to our neural processing power: we focus on the numerical comparison because it's a lot easier than the qualitative comparison.

Information technology makes it a lot easier and less costly for firms to adjust their prices (while allowing them to collect better information about the right direction and size of those adjustments).

So it's likely the more commerce we do on the net, the more importance will be attached to price - just as the economists have always assumed.

The dots linking us to Europe's woes don't join

2011-11-19T12:11:00.010+11:00

Humans are story-telling animals. We seek to understand developments in the world around us by turning them into ''narratives''.

When several things happen in the same field, people - including journalists - have a tendency to turn them into a coherent story by stringing them together.

For instance, the biggest economic news story for months has been the trouble the Europeans are having with their currency and high levels of sovereign debt, which are causing huge financial instability.
So, when, in the midst of this, our Reserve Bank cut the official interest rate and revised down its forecasts for the economy's growth, journalists and others joined the dots: clearly, and as might have been expected, the problems in Europe have caused a marked slowing in our economy.

There's just one problem: when you examine the facts, they don't fit the sense-making narrative people have woven them into.

The first point is that, despite the downward revisions to the Reserve's forecasts - which are unlikely to be very different from Treasury's revised forecasts when we see them in the next week or two - the economy isn't expected to slow down.

The truth is we've already had our slowdown when real gross domestic product contracted by 0.9 per cent in the March quarter of this year, mainly because of the effect of the Queensland floods. The economy has been recovering since that setback - but more slowly than expected because it is taking the Queensland coalminers so long to fix their flooded pits.

Over the year to last December, GDP grew by 2.7 per cent. Over the year to March, the growth rate dropped to 1 per cent and, over the year to June, it recovered to 1.4 per cent. The Reserve's latest forecast is for growth of 2.75 per cent over the year to December. Sound like a slowdown to you?

It's forecasting growth of 3 per cent to 3.5 per cent in 2012 and 2013. Is that weak growth? No, it's about ''trend'' - the economy's actual medium-term average rate of growth in the past and also the maximum rate at which it can grow over the coming medium term without worsening inflation, given the economy is already close to full capacity.

But, if the economy isn't slowing at present and isn't expected to slow, why has the Reserve had to revise down its forecasts? Because the economy isn't taking off the way the Reserve had earlier expected it would.

Admittedly, the main reason the economy now seems unlikely to really speed up is the dampening effect of Europe. The continuing saga has hit the sharemarket and made a lot of people feel poorer, as well as sapping the confidence of consumers and, more particularly, business people.

The Reserve cut the official interest rate a click - by 0.25 percentage points to 4.5 per cent - not because it feared disaster was on its way from Europe but because it now realised it wouldn't have as much trouble as it earlier expected keeping inflation within the 2 per cent to 3 per cent range over the next year or two.

A year earlier, it had tightened the ''stance'' of monetary (interest-rate) policy to ''slightly restrictive'' - one click above ''neutral'' (normal) - because it expected the economy to take off and push inflation above the top of the range. But now that was unlikely to happen.

As well, the Bureau of Statistics' move to a new series for the consumer price index had effectively revised history, showing underlying inflation in the June quarter wasn't quite as high as first thought and, for technical reasons, wouldn't rise as much in future.

There's plenty of evidence the economy isn't slowing and isn't likely to slow. For one thing, it's clear all the talk of ''the cautious consumer'' has been overdone. The weakness in retail sales (which in any case have been growing more strongly in recent months) isn't reflected in overall consumer spending, which is growing at about trend.

It turns out consumers have been changing their pattern of consumption rather than slowing the growth in it, buying less from department stores but more from service providers, including the providers of overseas holidays.

The acid test of whether consumers have become cautious is whether their spending is growing at a slower rate than their disposable income, thus causing their rate of saving to rise. The household saving rate seems to have stabilised at 10 per cent of disposable income.

The Reserve's revised forecasts imply it will rise a fraction in the short term, but be stable at 10 per cent over the next two years. If so, the laws of arithmetic say consumer spending will rise in lock-step with disposable income.

As for the index of consumer sentiment, although it fell heavily earlier this year, it's risen for three months in a row.

The economy is still receiving - and is expected to continue receiving - huge stimulus from the rest of the world, in the form of the resources boom. It's coming from the high prices we're getting for our mineral exports, from the growing volume of those exports and from hugely increasing investment spending on the development of new mines and natural gas facilities.

Although the Reserve believes our terms of trade - export prices relative to import prices - probably reached their peak in the September quarter and will now fall back, they're likely to stay better than we're used to. Iron ore prices fell heavily, but more recently are recovering.

It's true the labour market isn't as strong as it was last year. The unemployment rate has edged up from 4.9 per cent to 5.2 per cent. It may rise a little further, but then fall back. Overall, it seems about enough jobs are being created to cover the growth in the labour force.

And remember, with economists believing the lowest unemployment can go without causing inflation is about 4.75 per cent, we aren't travelling too badly.

The new forecasts are built on the assumption that sovereign debt problems in Europe don't cause a marked further deterioration in financial and economic conditions there. ''Fears of a major [global] downturn have not been borne out so far,'' the Reserve says.

There's a fair chance it could still happen, of course. But it's in no one's interests to jump to the conclusion it will.

Change is workers' only certainty

2011-11-16T11:56:00.002+11:00

The shape of our economy is always changing, but lately the pace of change seems to have got a lot faster. Some industries are expanding, while others contract. Particular industries are having to change the way they operate - or the range of products they produce - in response to many pressures.

These changes almost always leave us better off materially. ''Structural change'', as economists call it, has been central to the process by which people in the developed world have become ever more affluent over the past 200 years.

The greatest force driving structural change is technological advance: the invention of better ways of doing things, new things to do and countless labour-saving machines. Globalisation has been driven partly by government policy, but mainly by the information and communications technology revolution, which has hugely increased the speed and reduced the cost at which information, money and people move around the world.
This has given us the global financial markets, but also the rise of the developing economies, particularly in Asia. Those countries' growing demand for our minerals and energy is bringing us great wealth but is also bringing intense pressure for change in the shape of our economy. Mining and the services sector are expanding, whereas manufacturing, the tourism industry and education exporters are being forced to adjust.

Then there are all the industries under pressure from the internet and the emergence of ''new media'': newspapers, free-to-air television, book publishing and book selling, and retailers whose customers have discovered how much more cheaply they can buy some things on the net.

The trouble with structural change, of course, is that the benefits go to the customers - new products, wider choice, lower prices - while all the problems go to the people working in the disrupted industries.

Managers have to find a new plan for their firm's survival. Meanwhile, workers go through considerable uncertainty and anxiety. At best, they have to shift to doing something completely different. They may be required to do a lot more for the same money. Perks may be cut. Or their prospects of advancement curtailed.

They may lose their status as permanents. At worst they get shown the door and take a long time to find another job. That job may well involve doing the same work for less money and poorer conditions - perhaps for the business to which their work was outsourced.

Managers have no choice but to face up to the business's changed conditions and cut their cloth accordingly. When they resist change or pretend it isn't happening they just make things worse. Non-unionised employees have to cop whatever solutions managers impose on them. But well-unionised employees have more power to resist, or at least have their viewpoint taken into account.

No firm fits this frame better than Qantas. It has lost its protected status as the nation's flag-carrier and must find a strategy for competing with myriad competitors, many of them low-cost. It can no longer afford the high salaries and cushy conditions its pilots, engineers and other employees have become accustomed to.

The problem at Qantas was not that workers wanted too much in pay rises - that's the standard stuff of such bargaining - but that they wanted to use their industrial muscle to force management to agree never to change the business in ways that disadvantaged their employees.

Sorry, but that's not possible. Here you see the grounds for business's latest complaint against Julia Gillard's Fair Work changes to industrial relations. Gillard has removed the list of ''prohibited content'' restricting the matters over which management and unions may bargain. This has permitted the unions to range far beyond claims about wages and conditions to issues that concern ''managerial prerogative'' and thus challenge ''management's right to manage''.

It's important to remember we're still engaged in the difficult transition from almost a century of compulsory arbitration - where, as soon as a strike began the umpire would step in to impose a settlement on both sides - to a new world of collective bargaining.

A central goal in making this transition - one expressed many times by the now-bellicose Peter Reith - is to encourage the two sides to bargain without external intervention. The goal was a new era of reduced industrial disruption as the parties recognised the great extent of their common interests and put less emphasis on their (undoubted) conflicting interests.

Right on. So I don't think banning debate about management decisions is the smart way to go. That would mean the law advantaging one side, giving managers permission to ride roughshod over the interests and even the opinions of their employees.

Half the trouble at Qantas is the employees' failure to recognise how the game has changed for their company, robbing them of their former bargaining power. The other half is the arrogance of management in their resort to ''managerial prerogative'', in their failure to explain and debate the new realities with their staff.

It's painfully clear management-employee relations within Qantas are utterly poisonous. The blame for that should be shared equally. The fate of Qantas is important in its own right, but it's more important as a case study in how big, unionised companies cope with structural change.

The industrial parties need to reach an accommodation, not rush to the ref. But I agree with Professor Paul Gollan, of Macquarie University, that Fair Work needs to provide a better mechanism to help the parties argue through their differences in cases where belligerence on either side threatens to impose unnecessary hardship on the parties and the public.

Shouting slogans will not further Fair Work debate

2011-11-14T14:58:00.001+11:00

It's a compelling narrative: in the 1980s we deregulated the financial markets, slashed import protection and deregulated many markets for particular products. But then it dawned on us that deregulated, highly competitive product markets could hardly co-exist with a centralised, highly regulated labour market.

So Paul Keating started to deregulate the labour market, ending centralised wage-fixing and moving to collective bargaining at the enterprise level. The Liberals' Peter Reith introduced a formal system of individual contracts, Australian workplace agreements, then John Howard completed the process of deregulation by introducing Work Choices.

But then Labor used Julia Gillard's Fair Work Act to re-regulate the labour market. So we've reverted to our original problem of having a regulated labour market that simply doesn't fit with deregulated, trade-exposed product markets.

Just one problem with this neat analysis: it adds up only if you don't actually know much about how the labour market is regulated. The notion that Work Choices deregulated the market and Fair Work re-regulated it is simple, but makes no sense.

Consider this: the Work Choices legislation was much longer, more complex and more intrusive than the law it replaced. Does that sound like deregulation? The Fair Work legislation is considerably shorter and more straightforward. Does that sound like re-regulation?

One of the main complaints against Fair Work is that it has removed the list of ''prohibited content'' about which employers were prevented from agreeing with their unions. Inserting prohibitions in the law is deregulation? Removing prohibitions is re-regulation?

One thing Work Choices did was greatly bureaucratise the right to take industrial action, with the intention of discouraging it. Unions have to hold a postal ballot of their members and achieve a certain proportion of votes to commence a bargaining period after the expiry of their last enterprise agreement.

Then they have to hold another postal ballot before they can undertake protected industrial action during the bargaining period. Then they have to give 72 hours' notice of any action they actually intend to take.

By contrast, employers don't have to jump through any hoops or give any notice when they decide to retaliate by locking out their staff during a bargaining period.

These provisions of Work Choices were carried over largely unchanged in Fair Work. Do they sound terribly pro-union? Do they sound like deregulation? Does continuing them in Fair Work constitute re-regulation?

Confused yet? The simple truth is that ''deregulation'' isn't a sensible description of what Work Choices did and, in consequence, ''re-regulation'' isn't a sensible description of what Fair Work does.

Here's the point: the labour market has always been highly regulated. It remained highly regulated under Work Choices and it's still highly regulated under Fair Work. It's always likely to stay highly regulated for a simple reason: unlike all other markets, the labour market deals with human beings rather than the exchange of inanimate objects.

As a matter of politics, common humanity and common sense, the treatment of people in the labour market will always be carefully regulated. We are, after all, running the economy for the benefit of people.

What changes from time to time is not so much the degree of regulation as the objectives of that regulation. There's a fundamental imbalance of bargaining power between an individual worker and even the smallest employer.

So the main issue the regulation deals with is what should be done about that imbalance. The usual answer - the world over - is to permit workers to bargain collectively.

What Work Choices did - in its original form, at least, before Howard realised he'd gone further than the public would cop - was make individual bargaining far more attractive to employers by removing the ''no-disadvantage test'' which had limited the extent to which workers' wages and conditions could be reduced. A lot of the regulation it added to the system was to constrain the freedom of those employers who chose to continue bargaining collectively with their employees. And it further tightened restrictions on what unions could do.

Howard shifted the balance heavily in favour of employers and tried to delegitimise the (already declining) union movement. It's hardly surprising Labor used its first opportunity to shift the balance back the other way. What is surprising is how many of Work Choices' anti-union provisions it left intact.

All systems of collective bargaining permit unions to take ''protected'' industrial action, subject to certain tight conditions. Why do they need protection? What are they protected from? From being sued by employers in the civil courts because of the economic damage that action has done to the employers' businesses.

See what this means? It means that even if we really did attempt to deregulate the labour market by abolishing the industrial relations act, it would still be regulated by ordinary commercial law and common law. In that imaginary world, it would not be illegal to strike or take other industrial action, but any damage unions inflicted on employers - which, after all, is the very object of industrial action - would leave the unions open to being sued.

So, for all practical purposes, collective bargaining would be impossible - would be prevented by (ordinary civil law) regulation - unless governments regulated to specify the circumstances in which it would be permitted by being protected from actions for civil damages.

Still think it makes sense to talk about deregulating or re-regulating the labour market? There's always legitimate ground for us to debate whether the balance our industrial relations regulation strikes - between protecting workers on the one hand and achieving an efficient-functioning economy on the other - should be shifted in one direction or the other.

But shouting slogans at each other - it's deregulation if I like the latest changes; it's re-regulation if I don't - won't advance the debate one jot.

Storm clouds over Europe, but sun is shining elsewhere

2011-11-12T14:45:00.003+11:00

If you're confused about what's happening in the European economies, why it's happening and what it means for the world economy, don't feel you're alone.

The media's great strength is the speed with which they can bring us myriad details about the latest happening in Greece, Italy or anywhere else. Unfortunately, their great weakness is their inability to digest all that information and summarise what it means. The closest they go is in relaying the opinions of 101 supposed experts from Greece, Britain, America or anywhere else. Listen to more than one or two and you're soon none the wiser.

But this week our own secretary to the Treasury, Dr Martin Parkinson, gave us his tight summary of what and why and what next.

He began by warning that ''the global economy is heading down a winding road, with twists and turns ahead that we can't predict''. Following the global financial crisis, it was expected that the global economy would recover at a modest pace as the financial excesses were worked out of national, business and household balance sheets.

Instead, we've seen events occur that threaten to derail this recovery. ''The unfolding saga of the European sovereign debt crisis sees events change on a daily (if not hourly) basis,'' Parkinson says.

''It's not just events in Europe either, with the unprecedented downgrade by Standard and Poor's of their US sovereign credit rating in August providing yet another twist.''

He says there are four ''proximate'' (immediate) causes of the present situation in Europe. The first is the unsustainable sovereign (government) debts of some economies in the euro area, which reflect a period of weak economic growth and big budget deficits. This suggests a need for microeconomic reforms to enhance the country's international price competitiveness (because membership of the euro prevents the country from gaining competitiveness by devaluing its currency) and for more competitive taxation and social welfare policies.

The second cause of Europe's problem is policy responses from governments that are inadequate considering the size of government debt. This raises the fear of ''contagion'' (spreading disease) throughout the European banking system.

Third, the markets' continuing fear that political institutions are incapable of implementing concrete and credible responses to the problem.

And finally, a growing recognition by markets that the economic recoveries in both the US and Europe will be weaker than previously expected, making it even harder to work down their already excessive levels of government debt.

Financial markets around the world have been gripped by uncertainty and aversion to risk because of the prospect of weak global growth and the European sovereign debt crisis. Volatility has become the new norm.

The euro-area leaders' summit late last month finally made some much-needed announcements, but though markets initially reacted positively to these measures - despite the absence of detail - this was very short-lived.

Political developments in Greece and Italy in the past fortnight have further undermined confidence in the commitment of governments to deal with the underlying problems. Europe will remain a source of market volatility until governments' commitments are seen as clear and credible.

Market participants have become very reluctant to hold the bonds of certain governments, which is reflected in the market yields (effective interest rates) participants require to hold the bonds of particular governments.

The yield required on Spanish and Italian bonds, for instance, is about 5 percentage points higher than that for German government bonds. For Irish bonds this ''spread'' got as high as 12 percentage points, but has since fallen to about 7 points. For Portuguese bonds it's 10 percentage points and for Greek bonds it's about 30 percentage points.

Across the Atlantic, growth in the US weakened significantly in the first half of this year. Though it's strengthened a bit since then, the recovery remains vulnerable to external shocks such as a re-intensification of the European debt crisis.

''In the longer term we can have confidence that the US economic system will drive the innovation and investment needed to spur competitiveness and growth,'' Parkinson says. ''The question is whether the US political system can mobilise itself to address its medium-term fiscal challenges.''

But while both Europe and the US face budgetary challenges, there are some crucial differences, he says. Critically, the US has its own currency and monetary policy and a fiscal (budgetary) union between its 50 states.

And with the yield on 10-year US Treasury bonds at about a 60-year low, there's zero pressure from the market to force political action - and a political compromise - on a substantial medium-term reduction in the US budget deficit.

But until such a plan is agreed and legislated, the US will remain at risk of a sudden shift in market sentiment, as Italy has discovered in recent months.

Parkinson remarks that, with economic commentary focused on the short term and the North Atlantic, it's easy to overlook the bigger picture. We are in the midst of a once-in-a-century global economic transformation as the world's centre of economic gravity shifts from the advanced economies to the emerging market economies.

We focus on the rapid growth of China and, to a lesser extent, India. But we shouldn't overlook the strong growth of Indonesia and Vietnam. With a population of almost 240 million, Indonesia is the world's fourth most populous country. If we measure it using purchasing-power parity (as we should), Indonesia's economy overtook Australia in size in 2005.

Parkinson also points out that the rise of the developing countries isn't limited to Asia. ''We see a similar story developing in other emerging economies,'' he says.

''For example, a young population and improvements in human capital will likely contribute to an expected doubling in South Africa's gross domestic product in the next 20 years and Nigeria is expected to increase three-fold to displace South Africa as the continent's largest economy by the late 2020s.

''Latin America also continues to surge forward, with Brazil and Chile leading the way - with both expected to double in size by 2030.''

Returning to Asia, despite rapid growth in living standards, China and India remain at the early stages of their economic development. Assuming broad trends continue, China and India's cities will be populated by an increasing wealthy and mobile middle class in the decades ahead. ''On some projections, there will be 1.7 billion middle-class consumers in the Asia-Pacific region by 2020 - more than the rest of the world combined.''

Remember, however, all these projections rest on the economists' de rigueur assumption that there's no way shortages of natural resources or environmental pressures could prevent the global economy from continuing to grow forever.

We may be two-speed, but we are all sharing dividends

2011-11-09T12:24:00.001+11:00

Forgive my absence at such an anxious time but I've been away on holiday in Western Australia, walking bits of the Bibbulmun Track, which runs from Perth to Albany. The wildflowers were unbelievable. And so was the affluence in Perth, where the mining companies' skyscrapers are so tall they can be seen from Rottnest Island, 19 kilometres away.

How'd you like to be living in Perth, in the winners' circle where everything is on the up, not doing it tough in Sydney or Melbourne, on the wrong side of the two-speed economy?

Actually, things in Perth aren't as wonderful as it suits envious easterners to imagine. Know what they complain about in the West? The two-speed economy. Most of them think they're missing out. Some people may be raking it in, but not me. I'm not on some fabulous salary, just paying the exorbitant house prices the well-to-do have brought about.

Now where have I heard that before? What is it about Australians at present - on both sides of the continent - that makes them so convinced they're missing out and battling to get by?

According to polling by Labor, 68 per cent of respondents believe average Australians aren't benefiting from the mining boom. Is that how you feel? If so, you haven't thought about it. As someone said, there are more things in heaven and earth than are dreamt of in your philosophy.

After such a long plane trip, I was half expecting WA to be like another country. And it's true they have things we don't: magnificent tall trees - jarrah, karri and marri - and strange animals such as quokkas. But step into the bush and it's very much part of Australia: gum trees everywhere, kangaroos and kookaburras.

It's the same story economically. They may have huge reserves of natural gas and iron ore that we don't, but their economy is really just a corner of the greater Australian economy. As the locals are the first to tell you, a lot of the money they make soon finds its way into the pockets of people Over East.

For a start, there are no customs barriers between the states, so there's a lot of trade between them. Step into a WA supermarket and you see they're selling just the same stuff ours do. Which means most of what they're selling was manufactured on the east coast.

Their big mining companies have been making huge profits for the best part of a decade. Nothing to do with you? Every east-coaster with superannuation has a fair bit of their savings invested in the shares of those big companies. So you've been getting your cut.

Your super's been looking a bit sick in recent years? That's mainly because of problems in the rest of the world. Whatever you've got, it'd be looking a lot sicker without the resources boom.

Those mining companies are subject to the federal government's 30 per cent tax on company profits. And the feds' company tax collections have been massive since the resources boom started in the early noughties.

Do you realise that under Howard and Rudd we had cuts in income tax eight years in a row? Where do you think the money came from to finance those cuts?

In the economy, everything's connected to everything else. So if you're conscious of only the direct connections you're missing a lot of the story. And no connection is more indirect - or mysterious - than the way the governments of NSW and Victoria have been benefiting from the good fortune of the WA and Queensland governments.

This arises from our longstanding commitment to the principle of ''horizontal fiscal equalisation'' - which holds that all Australians, no matter where they live, are entitled to the same quality of government services.

That ain't easy, particularly because most government services - education, hospitals, law and order, roads - are delivered by the states. The cost per person of delivering services varies with how big and decentralised the states are. But another factor is the states' varying capacities to raise revenue. These days, states gaining royalty payments from their big mining industry have considerable ''taxable capacity''.

To bring horizontal fiscal equalisation about, the Commonwealth Grants Commission does many intricate calculations which determine how the $48 billion-a-year proceeds from the feds' goods and services tax are divided among the states. The commission works out the average amount of GST paid per person throughout Australia, then decides whether each state requires more or less than that, per person, to be able to deliver services of equal standard.

This equalisation process was introduced in the early 1930s to mollify the restive West Australians. Until just a few years ago, it meant Victoria and NSW got a lot less than the national average, while South Australia and Tasmania got a lot more than average and Queensland and WA got a bit more.

In 2004-05, NSW got just 83 per cent of the national average GST paid per person, while Victoria got 84 per cent. WA got 104 per cent and Queensland got 107 per cent (with SA getting 123 per cent and Tasmania 171 per cent).

But the huge increase in the resource states' taxable capacity thanks to booming mining royalties has changed all that. This financial year NSW's cut has risen to 96 per cent and Victoria's to 90 per cent, whereas Queensland's cut has fallen to 93 per cent and WA's to - get this - 72 per cent.

It works out that, in effect, Queensland's benefit from its mining royalties this year will be reduced by $1.2 billion and WA's by $2.5 billion. Of their combined loss of $3.7 billion, NSW gains $1.3 billion and Victoria $1.8 billion.

Still think you're getting nothing from the boom?

Brave economist blows whistle on bosses' pay

2011-10-17T10:24:00.001+11:00

You could be forgiven for not knowing it, but economists are meant to be tough on business. Their ideology holds that capitalism is good not because it's good for capitalists, but because it's good for consumers - and consumption is "the sole end and purpose of all production".

So said Adam Smith, who added that "the welfare of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer".

The economists' ideology holds that, when markets are working properly, most of the benefit flows to consumers in the form of lower prices and better service, with businesses making no more that "normal" profits (the lowest rate of profit needed to keep the firm's resources employed in its present industry).

Economists should also distinguish between the capitalists (the suppliers of capital - the shareholders) and the managers, who are supposed to be merely the agents of the shareholders who must at all times represent the true interests of the shareholders, never their own interests. Likewise, company directors are supposed to represent the shareholders' interests, not management's interests.

So economists are supposed to be pro-market, not pro-business and certainly not pro-management.

That's how it's supposed to be, but often not the way it is. In practice, economists who work for business aren't free to criticise it in public. The same goes for those who work for conservative governments (or Labor governments anxious to keep on side with business). And few academic economists take an interest in such mundane issues.

But another factor that helps explain the gap between principle and practice is that the economists' basic model recognises no role for collective action, including action by governments. So when things go wrong in markets, economists' first inclination is to defend the market and blame governments.

All this explains why economists have such a poor record in speaking out about excessive executive remuneration - as witness, the Productivity Commission's report on the subject of a few years back. That this is a case of market failure is as plain as a pikestaff, but the commission's economists searched under every rock without finding it.

One honourable exception to this glaring dereliction, however, is Diane Coyle, who tells it as it is in her latest book, The Economics of Enough. As her previous bestsellers attest, Dr Coyle - whose PhD is from Harvard - is a most orthodox economist.

Seeking to explain the origins of the explosion in executive pay, she attributes it to the deregulation of the financial markets in the US, Britain and elsewhere.

"Organised crime aside," she says, "the most ostentatious flaunting of wealth has emanated from the banking sector. As it turns out, these vast earnings and bonuses were undeserved. The bankers [in the US and Britain] ran up large losses, ruined their shareholders, and left taxpayers with the bill. It will be extraordinary if they turn out to have fooled, scared or bullied politicians around the world into stepping back from fundamental reform of the banking sector."

But the key point is the impact such high incomes in banking have had on the rest of society.

"The bonuses far in excess of salaries, and the spending on big houses, fast cars and designer clothes they funded, did create a climate of greed," she says.

"People in other professions who are in reality in the top 1 per cent or even 0.1 per cent of the income distribution were made to feel poor by the bankers.

"Banking bonus culture validated making a lot of money as a life and career goal. It made executives working in other jobs, including not only big corporations but the public sector too, believe that they deserved bonuses.

"Remuneration consultants, a small parasitic group providing a fig leaf justification for high salaries, helped ratchet up the pay and bonus levels throughout the economy.

"The whole merry-go-round of bonuses and performance-related pay is a sham. In almost every occupation and organisation it is almost impossible to identify the contribution made by any individual to profits and performance - complicated modern organisations all depend on teamwork and collective contributions."

So what can be done about it? In late 2009, the British government introduced a penal tax on bonuses above #25,000 in banking. The tax was criticised, not only by bankers but also by others who thought the measure impractical.

"But it was one of the few measures any government has so far taken that was absolutely right. The symbolism is vital even if by itself the measure doesn't bring to an end the corrosive culture of greed. Whatever the practical limitations on their actions, governments can still achieve a lot in symbolic terms, which should never be underestimated when it comes to impact."

And governments could do a lot more to change the social norms that helped destroy the Western financial system. For example, they could halt bonus payments in the public sector altogether, or introduce a general additional tax on non-fixed parts of people's pay packages.

"I am not opposed to people making more money if they studied hard or worked hard for it, or took the risk of setting up a successful new business - on the contrary, effort and entrepreneurship must be rewarded amply," Coyle says.

"Nevertheless, governments have to give a lead in restoring the sense of moral propriety and social connection between those people who are part of the extraordinarily wealthy global elite and the great majority of those with whom they share their own nation.

"Senior bankers should also contribute to this task of making greed and excess socially unacceptable once again." Amen to that.

Understanding the Aussie dollar

2011-10-15T07:33:00.000+11:00

Economic theory tells us the level of the exchange rate is an important factor in the health of the economy. Unfortunately, there's nothing in economic theory that can explain the Aussie dollar's strange behaviour in recent weeks. It's hard to know whether to cheer or boo.

We do know the Aussie has a strong and longstanding tendency to move in line with the prices we're getting for our commodity exports so, since during the past few years the prices of coal and iron ore have moved to record highs, it hasn't been surprising to see the Aussie rising to heights not seen since before it was floated in 1983.

It hit a peak of 110 US cents in early August, but seemed to settle at about 105 US cents. But in late September, during a bout of considerable anxiety on world markets about the state of the North Atlantic economies, it fell below parity, eventually getting down as low as 95 US cents.

But then this week it began going back up, reaching comfortably above parity, jumping 3 US cents in just 12 hours on Wednesday.

It's possible we've reverted to an earlier pattern where, when the global financial markets get particularly anxious about economic prospects, investors liquidate their short-term investments offshore and bring their money home to the safe haven of investment in government bonds. So the dollar appreciates (rises in value) and most other currencies depreciate (fall in value). Remarkably, this knee-jerk reaction can occur even when uncertainty about the fate of the economy is a major part of the anxiety.

That's step 1. Step 2 is for investors to calm down and start moving their money back overseas to destinations such as Australia in pursuit of higher returns than offered by bonds. If so, maybe that's what happened this week.

And if that's so, maybe step 2 has merely taken us back to square 1 - a dollar that settles well above parity. But who could be sure US cents Who knows what will happen the next time something really scary happens in Europe or the US cents Will the Aussie drop to, and stay at, a new level significantly below the 105 US cents it seemed to have settled at, or will it just go through a period of high volatility without actually changing its general level US cents

A point to note is that, though the media and markets' focus is always on our exchange rate with the greenback, economics teaches that what matters to the economy is our exchange rate with all our trading partners, not just the Americans.

Say you were taking a holiday in Britain. What would matter to you is our exchange rate with the pound. If you were going to Japan, it would be our exchange rate with the yen. In neither case would you regard our exchange rate against the greenback as particularly relevant.

It's the same story when Australian firms trade with Britain or Japan. Even if the price happens to be set in dollars - as it often is - the Aussie firm will translate that price into Aussie dollars, while the British or Japanese firm will translate it into their own currency.

Put the two together and what matters for the transaction is the Aussie-pound or Aussie-yen exchange rate. So we should be interested in our exchange rate with each of the countries with which we trade. And how much each bilateral exchange rate matters to us depends on how much trade we do with the particular country.

See where this is leading US cents The exchange rate that matters to the economy overall is the average exchange rate for all our trading partners, with each country's currency weighted according to its share of our two-way trade. Economists call this our ''effective'' exchange rate, which is represented by the trade-weighted index.

When you look at what's happened to our exchange rate against that index, you find the volatility in recent weeks is less. While we've depreciated against the greenback, we've appreciated against the euro and the Korean won.

There's always a lot of focus on what's happening to interest rates because we all know how important the rate of interest is to the strength of the economy. A rise in rates will slow economic growth by discouraging borrowing and spending; a fall in rates will hasten growth by encouraging borrowing and spending.

What's less well recognised is that the level of the exchange rate also affects the strength of the economy. So much so that the Reserve Bank brackets the two - interest rate and exchange rate - as ''monetary conditions''. When the exchange rate appreciates, this tends to slow the economy by reducing the price-competitiveness of exports and those domestically produced goods that compete against the now-cheaper imports in our domestic market.

It doesn't have much effect on domestic demand (our spending), but it does slow the growth of aggregate demand (our production - gross domestic product, in fact) by reducing exports and by diverting more of our spending into imports.

Conversely, when the exchange rate depreciates, this tends to speed the economy by improving the price-competitiveness of our export and import-competing industries. Domestic demand isn't much affected, but GDP improves because we export more, and more of our spending goes on domestically produced goods and services rather than imports.

This, of course, is why our manufacturers have been doing it tough under the high exchange rate. They've found it harder to export and to compete against imports. Though it's received far less public sympathy, our tourist industry has suffered in the same way, with fewer foreigners coming to Australia and more Aussies holidaying abroad rather than locally.

Our universities and other education exporters have been hit also.

So I'm quite sorry to see the dollar going back up this week after having fallen by up to 10 per cent from its heights. It would have been great to take a bit of the pressure off the manufacturers, tourist operators and education exporters.

The econocrats have a rule of thumb saying a sustained fall in the exchange rate of 10 per cent should lead to a rise in real GDP of about 0.75 percentage points over the following two years - say, 0.4 points in each year. (The rule also holds for a rise in the exchange rate causing slower GDP growth.)

So whereas a lasting fall in the Aussie might have been bad news for motorists (price of petrol) and people planning overseas trips, it would have helped make our multi-speed economy a little less uneven.

Look within to pick up productivity

2011-10-12T07:50:00.000+11:00

One of the tricks to success - in business, or in life - is to focus on the things that matter, not the things people (and hence, the media) are getting excited about this week. Of late we seem to be doing a lot of worrying about the wrong things.

For instance, our preference for bad news over good means we've been doing a lot of hand-wringing over the economic problems in Europe and the US. What's happening in China and the rest of developing Asia may be far less worrying - and hence, less interesting - but it's also far more important to the fate of our economy.

When we look at our economy, we give much more attention to the alleged two-speed economy - who's feeling hard done-by this week? - than to the truth that, with limited exceptions, the economy has been travelling well, is travelling well and is likely to continue travelling well.

As part of this, of late we've been devoting inordinate attention to the problems of the manufacturing sector (which accounts for 9 per cent of total employment), without any concern for the services sector (accounting for a mere 85 per cent of employment), even though two big service industries - tourism and education - have also been hard hit by the high dollar.

But even those of us happy to acknowledge how well our economy's travelling, thanks to high export prices and the mining construction boom, are less conscious of the sad truth that, underneath all that, the economy's productivity - output per unit of input - has stopped improving.

We're getting richer because the world is paying us a lot more for our exports and is engaged in a massive expansion of our mining industry, not because our businesses are getting more efficient at what they do.

That message is, however, getting through to big business and its various lobby groups. Only trouble is, in their search for a solution to the productivity problem they've been looking outside their firms, not inside. Perhaps if the government reformed the tax system, that would lift productivity. Or maybe going back to Work Choices would help.

It's possible that, while they come to our attention only when they're putting their oar into the public debate, most chief executives are busily engaged attending to their own, internal affairs. It's possible, but there doesn't seem much evidence of it.

That's why the most useful thing to come from last week's jobs forum in Canberra was the unveiling of a study on the leadership, culture and management practices of high-performing workplaces, sponsored by the Society for Knowledge Economics with funding from the federal government.

A team of academics from the University of NSW, the Australian National University, Macquarie University and the Copenhagen Business School examined 77 businesses in the services sector with more than 5600 employees. Most were medium size, and included law and accounting firms, advertising companies, consulting firms and employment agencies.

It's probably the most comprehensive study of workplace performance undertaken in Australia in the past 15 years. The performance of businesses was measured in six categories: profitability and productivity, innovation, employee emotions, fairness, leadership and customer orientation.

The study identified 12 high-performing workplaces and 13 low-performing workplaces, leaving most of the firms studied somewhere in the middle. So what are the characteristics of high-performing workplaces and how much better are they than the low-performing?

Well, not surprisingly, the best performers were more profitable and productive. According to the lead researcher, Dr Christina Boedker, high-performing workplaces are up to 12 per cent more productive and three times more profitable.

And it's not too surprising the best performers are better at innovation. They generate more new ideas and are better at capturing and assessing their employees' ideas. In consequence, they make more improvements to services and products, production processes, management structures and marketing methods.

But some treat-'em-mean-to-keep-'em-keen managers will be surprised that high-performing outfits do better on employee emotions. They have higher levels of job satisfaction, employee commitment and willingness to exert extra effort, and lower levels of anxiety, fear, depression and feelings of inadequacy. Part of the bottom-line consequence of this is lower rates of staff turnover.

The employees of high-performing firms tend to be more satisfied people, are being paid fairly and company policies are being implemented fairly.

High-performing firms rate better on customer experience. They try harder to understand customer needs, are better at acting on customer feedback and better at achieving their own goals for customer satisfaction.

But the study is particularly concerned with the performance and attitudes of managers, which business-types these days put under the heading of ''leadership''. In high-performing outfits, managers and supervisors devote more time to managing their people, have clear values and practise what they preach.

They welcome criticism as a learning opportunity. They foster involvement and co-operation among staff, give them opportunities to lead activities, encourage development and learning, give them recognition and acknowledgement and encourage them to think about problems in new ways.

The management practices that do best, according to the study, are being highly responsive to changes in customers' and suppliers' circumstances, encouraging high employee participation in decision-making, achieving on-the-job learning through mentoring and job rotation, making effective use of information and technology and attracting and retaining high quality people.

Of course, different managers have different cultures or styles. Some emphasise results, some their people and some coping with change. The study finds all three approaches can make a high-performance workplace. The one style that doesn't work is the ''control'' culture.

Wow. How'd you like to work for such a boss in such an enlightened business? Pity is, such firms accounted for only 15 per cent of the sample.

Taxation reform is a cargo cult for business

2011-10-10T09:02:00.000+11:00

When you look at the varied contributions to the public policy debate made by business people and their lobby groups, one attitude unites them: the politicians owe them a living.

Government, it seems, has one overwhelming responsibility: to make life easier for business. You see this in business people's views on "competitiveness". Economics has a lot to say about competitiveness, but not what business people imagine it says.

To them, competitiveness refers to the ability of Australian firms to compete in international markets against the enemy, firms from other countries. It's a zero-sum game, apparently: either we win and they lose, or they win and we lose.

Hence our government's obligation to improve our team's competitiveness by cutting the taxes Australian firms have to pay or by weakening the bargaining power of employees and so cutting our firms' labour costs.

What economics actually says is, first, trade is a positive-sum game: both countries win by exploiting the "gains from trade". Second, competitiveness isn't a gift governments confer on their businesses, it's a stricture they impose as the best way of ensuring firms aren't able to make excessive ("super normal") profits at the expense of the intended beneficiaries of competitiveness, Aussie consumers.

Most of the micro-economic reform project was aimed at increasing competitiveness by making life tougher for business: by reducing protection against competition from imports (the exports of our supposed enemies), by removing regulations that inhibited competition between local firms, and by beefing up prohibitions on anti-competitive practices.

We know micro reform failed to achieve a lasting increase in the rate of productivity improvement. Its lasting benefit has been to make the economy more flexible and resilient in response to economic shocks.

In particular, by increasing the intensity of competition in so many markets it has robbed many businesses of their former pricing power - including their ability to conclude sweetheart deals with their unions - and made our economy markedly less inflation-prone.

So much for the happy notion micro reform involves governments making life easier for business.

Further evidence of business's cargo-cult attitude to the role of government can be seen in its approach to tax reform. Business has an insatiable obsession with taxation. It wouldn't matter how much reform we'd achieved, its demands for more reform would be undiminished. That's because it's convinced the less tax it has to pay the easier its life will be.

There's a large element of self-delusion in this. Neither business people nor punters genuinely understand that, in the final analysis, companies - being inanimate objects - don't bear any tax burden. In the end, only humans pay tax - whether they're the owners, the managers, the employees or the customers of the company.

Just how the ultimate burden of all the various taxes companies pay is shared between those groups does matter, of course, but that's a complex empirical question with uncertain answers. And it's a safe bet all the sparring over company tax at last week's tax forum was motivated more by perceptions and appearances than empirical realities.

The key reform demanded at the forum, pushed hard by the Business Council, was for the rate of company tax to be cut from 30 to 25 per cent, with the cost to be covered by an increase in the GST.

Don't like the sound of that one? Neither did the union reps. But, cried the business people and the tax economists, didn't you know empirical studies show the ultimate "incidence" of company tax falls largely on labour? Since much the same is true of the GST, what rational reason could unions have to object to such a neutral rebalancing of the tax mix? But that question cuts both ways. If the ultimate incidence of company tax is borne by labour, why are company executives so desperately keen to get its rate reduced? (And how do the tax economists explain why such a shifting of the furniture would be so clearly beneficial for the economy overall?)

A point rarely mentioned is that the existence of dividend imputation means the local shareholders of companies have nothing to gain. For them, a lower company tax rate just means smaller franking credits. And that being the case, exactly why does big business imagine a lower company tax rate would be such a benefit? Perhaps because many, maybe most, of the chief executives who make up the Business Council actually represent the interests of foreign shareholders, who aren't subject to the imputation system.

For further evidence of business's cargo-cult mentality, consider what I call the "leadership theory of tax reform", so much in evidence at the forum. Consider the air of righteous disappointment exhibited by business leaders and commentators when Julia Gillard failed to meet the Business Council's demand that she commit to a 10-year program of tax reform.

Oh, if only the government would exhibit some Leadership, they cried. Come again? This government is already knee-deep in unfinished tax reform, all with no active support from business (the deeply divided Business Council) and much active opposition (the business coalition running TV ads against the carbon tax).

This is even though some businesses urged the reform on the government (we want certainty on the price of carbon) and many parts of business stand to gain from the mining tax (20 per cent of the desired cut in the company tax rate, concessions to small business and a one-third increase in the captive market compulsory super delivers to the financial services industry).

All the righteous calls for politicians to show Leadership on tax reform come without the slightest commitment that business will back up the leader when the going gets tough. Dream on, guys.

Doomsday rate cut scenarios off mark

2011-10-08T08:56:00.002+11:00

If the Reserve Bank ends up cutting the official interest rate by 0.25 percentage points on Melbourne Cup Day, it won't be because the economy has weakened so much as because it's not looking as strong - and thus, inflationary - as the Reserve had earlier expected.

The air is full of uncertainty and fear about the fate of the European and American economies, with one excitable pundit even predicting a ''world recession''. But, short of a major meltdown, the North Atlantic countries' troubles won't be a big part of the Reserve's reasons for fine-tuning the stance of its monetary (interest rate) policy.

No one knows what the future holds, and there's a ''non-trivial probability'', as the economists say, that the US economy will start contracting again and, more significantly, the problems in Greece will be so badly handled that the European economies implode.

Were that to happen, be in no doubt: the Reserve wouldn't just be lowering rates by one or two clicks, it would be slashing rates in much the way it did in the global financial crisis of 2008-09. But that's far from the authorities' ''central forecast''. They expect the US to grow by a bit under 2 per cent next year, while the euro area achieves no growth.

What would plunge Europe and the world back into crisis - with Europe entering a period of severe contraction - would be for Greece to leave the euro. That's because of the panic this would cause to euro depositors in many other member-countries.

It's likely the Europeans well understand what they need to do to avoid a conflagration: first, restructure the Greek government's debt (which means bond holders accepting big write-downs); second, recapitalise those European banks hard-hit by the write-down; third, have the European Central Bank purchase large quantities of European governments' bonds so as to lower bond yields and, hence, commercial interest rates.

So the Europeans' problem isn't knowing what to do, it's achieving the agreement of 17 squabbling member-countries to do it. The likeliest outcome is that they do enough to avert catastrophe, but not enough to prevent recurring episodes of financial-market jitters.

Our authorities' forecasts for 2012 aren't far from those the International Monetary Fund published last month. These have the US growing by 1.8 per cent and the euro area by 1.1 per cent. If so, that leaves the world economy growing by, what - 1.5 per cent? No, by 4 per cent - which is about the trend rate of growth. Huh?

What's missing from the sum is China's growth, expected to slow to a mere 9 per cent, and India's, to a paltry 7.5 per cent. Even Latin America is expected to grow by 4 per cent and sub-Saharan Africa by 5.8 per cent.

So much for a world recession.

Weakness in the North Atlantic doesn't equal weakness in Australia by a process of magic. You have to trace linkages between them and us. An important one is psychological: the effect of a sliding sharemarket, worrying news from the North Atlantic and over-excited talk of world recessions on the confidence of Australian consumers and business people.

As for ''real'' (tangible) linkages, these days the US and Europe aren't big export customers of ours. So the key question is the extent to which weakness in the North Atlantic leads to weakness in China, India and the rest of developing Asia.

These days, China is a lot less dependent on exports to the North Atlantic than it used to be. And the Chinese authorities have both the political imperative and the economic instruments needed to keep domestic demand growing fast enough to prevent much of a slowdown in production and employment growth.

So, barring a European implosion, the North Atlantic troubles' effect on us is likely to be limited mainly to their effect on confidence. If so, what are the domestic factors that could lead the Reserve to lower interest rates a little?

In May the Reserve was forecasting growth in 2011 of 4.25 per cent. In August it cut that to 3.25 per cent. Today it would probably say 3 per cent.

But get this: the overwhelming reason for these revisions is the temporary effect of the Queensland floods, in particular the loss of output from coalmines that are taking far longer than expected to resume production.

There have been various highly publicised areas of weakness in the domestic economy - the troubles our manufacturers are having coping with a high exchange rate, very weak department store sales and weak housing starts - but overall (and excluding extreme weather events), there's little sign of weakness.

Despite the much-publicised fall in

consumer confidence, consumer spending grew by 3.2 per cent over the year to June, bang on trend. Business investment has been strong and is sure to get stronger. And earlier figures showed worsening inflation and worryingly strong growth in labour costs per unit of production.

Indicators released this week show strong growth in exports and strengthening retail sales, home building approvals and non-residential building approvals.

The strongest evidence of weakening is in the labour market, with employment growth clearly slowing from its earlier fast past, and the unemployment rate jumping 0.4 percentage points to 5.3 per cent in just two months.

But this is a puzzle because, though growth in employment is weak, growth in hours worked isn't. And though surveyed unemployment is supposed to have jumped, the number of people on the dole is steady.

So how does the Reserve come to be contemplating lowering the official interest rate a little? Because its job is to keep interest rates at a level sufficient to keep inflation travelling within its 2 to 3 per cent target range, and the outlook for inflation has become less threatening.

For a start, the Bureau of Statistics has revised the underlying inflation rate over the year to June from 2.75 per cent to 2.5 per cent. Second, the outlook for economic growth isn't quite as strong as it had been. And third, the atmospherics of the labour market have improved, with more consumers worried about losing their jobs and employers less worried about the emergence of excessive wage demands.

The present stance of monetary policy is ''mildly restrictive''. But if the risk of inflation rising above the target range is now much reduced, the stance of policy should be returned to neutral. That would require a fall in the official rate of just one click - two at most.

Tax cut buffet but no appetite for fixes

2011-10-05T12:45:00.001+11:00

Seen anything on the tax reform smorgasbord you fancy? How about cuts in the top two rates of income tax? How about abolition of conveyancing duty? Or maybe an end to stamp duty on insurance policies?

For business people there's a special range of goodies on display: a cut in the company tax rate to 25 per cent, special tax breaks for mining and construction companies that use Australian steel, abolition of payroll tax. Or maybe cuts in company tax that are limited to small businesses.

Don't see anything that particularly appeals? That's OK, why not concoct your own, custom-built concession? It's a bit late, but why not email it in as a submission to the tax forum? Be sure to say it will do wonders for the economy - which is why you're proposing it, naturally. I'm sure it will get as much consideration as all the other submissions.

Sorry, but the tax forum reminds me of nothing so much as a bunch of kiddies lining up to sit on Santa's knee and whisper into his ear what they'd like for Christmas. Dream on, kids. The harsh truth is that neither the federal nor the state governments are in any position to simply cut this tax or that. They're all struggling to get their budgets back to surplus.

So one of the ground rules Wayne Swan laid down was that all proposals for tax reform had to be "revenue neutral" - if you cut one tax you have to increase another by the same amount. You'd like to pay less income tax? No probs - we'll just increase the rate of the GST to cover it. Or maybe we could increase the rate and remove the exemptions for food, education and health care. That would make the GST a far more robust revenue-raiser.

Increase GST revenue far enough and we could also afford to abolish the payroll tax business keeps whingeing about. As for conveyancing duty, the ideal way to finance its abolition would be to broaden annual land tax to cover owner-occupied homes. Someone has suggested local government could be paid a fee to collect it along with council rates.

Kind of takes the fun out of tax reform, doesn't it?

Of course, were governments to get serious about reform there are a lot of other worthy but nasty things they could do. Bite the bullet and get rid of negative gearing, for instance. Stop family trusts being such a tax lurk. Crack down on the abuse of work-related deductions (especially by doctors and lawyers jetting off to conferences at exotic resorts).

Then there's superannuation. It's always been taxed heavily in favour of high income-earners, but Peter Costello's decision to make all private pension income tax-free to people 60 and over was the ultimate in favouring wrinklies over workers.

I should tell you the latest fashion among tax-reform aficionados is for income (particularly high incomes) and capital (particularly companies and capital gains) to be taxed more lightly, with consumption and real estate taxed more heavily.

This is because financial capital and high income earners are more mobile internationally - more capable of moving to countries where they're taxed more lightly - whereas wage-slaves and consumers are far less mobile and real estate is utterly immobile.

So, in an era of growing tax competition between countries, you tax those who can't escape more heavily and those who can escape less heavily. That this means the well-off pay less tax while the middle class and the workers pay more is purely coincidental, I assure you.

If you're detecting a touch of cynicism in my reaction to all this, you're not wrong. Economists, business people and professional lobbyists would happily meet in Parliament House once a month to preach to each other about the need for tax reform.

But if ever there was a country that runs a mile at the hint of tax reform, we're it. Most of the rest of the developed world introduced a GST in the 1960s and '70s, but we trembled on the brink for 25 years before taking the plunge in 2000.

The way tax reform works in Australia is that whenever governments are persuaded to introduce some major reform, the opposition automatically opposes it and starts a hugely successful scare campaign, urged on by every adversely affected interest group, the shock jocks and any other media outlets looking for cheap cheers.

Meanwhile, the people who'd benefit from the reform - even those who pressed the government to take it on - fall silent or, like the Business Council, get cold feet and run around saying the time is not yet ripe. All the academic urgers peel off the moment the government introduces a less-than-pure element to its scheme.

The obvious truth is Julia Gillard would need her head examined to take on more tax reform at present. Her plate is already over-full. You'd never know it from all the chat this week, but we're already engaged in two vitally important tax reforms: the carbon tax and the mining tax. The first is complicated but minor in its effect on household budgets; the second is a no-brainer.

Yet Tony Abbott has been hugely successful in his dishonest scaremongering against both taxes. He is campaigning against all tax reform, promising to reverse both measures and pretending taxes only ever need to be cut. Are the Liberal-leaning reform advocates doing anything to set him straight? Hell no - that's Julia's lookout. And the polls say the man with the neanderthal views on tax reform will be swept into office at the first opportunity.

When it comes to tax reform, Australians are utterly lily-livered.

Two minds make us all muddled thinkers

2011-10-03T13:03:00.000+11:00

Conventional economics got set in its ways long before neuroscientists discovered something that helps explain why the decisions consumers and business people make are often far from rational: our brains have two different, and sometimes competing, systems for deciding things.

Psychologists call it system one and system two thinking. System one is our intuitive system of processing information. It's fast, automatic, effortless, implicit and emotional. It's controlled by the earlier, more primitive part of our brain. It's highly efficient and is thus the most appropriate tool for the majority of mundane decisions we make every day.

By contrast, system two thinking is slower, conscious, effortful, explicit and more logical. It's controlled by the more recent, frontal part of our brain. When we weigh the costs and benefits of alternative courses of action in a systematic and organised manner, we're engaged in system two thinking.

In the hands of scholars who study behavioural ethics - such as Max Bazerman and Ann Tenbrunsel, the authors of Blind Spots - system one is seen as our "want-self" and system two as our "should-self". Almost all of us regard ourselves as ethical. Before decisions arise our should-selves think "I should behave ethically, therefore I will".

When we're looking back on decisions, our should-selves think: "I should have behaved ethically, therefore I did." Trouble is, when the decision is actually being made, our want-selves take over and we often do things that ignore the ethical implications of our actions.

The task for behavioural ethicists, therefore, is to help us find strategies that allow our should-selves to dominate our want-selves. In another context, psychologists say we have different systems for wanting things and liking things. So some of the stuff we really want, and spend a lot of time pursuing, doesn't give us as much satisfaction as we thought it would once we've got it.

This explains why children will spend weeks nagging parents to buy them a guitar or a pet but quickly lose interest once they have it.

It also explains a lot of futile adult behaviour. I suspect our two thinking systems explain the paradox of advertising. I'm not influenced by all the advertising I see, but a lot of people are. Do you think that, too? Trouble is, most people think it.

If it's true, just who are the dummies that fall for advertising? And how come so many businesses spend millions on advertising, convinced it's money well spent?

I think all of us are more susceptible to advertising than we realise. Most advertising is designed to appeal to our emotions and instincts, not our intellect. In other words, it's aimed at our unconscious, system one decision-maker and we're not conscious of the way it affects the choices we make. Meanwhile, our conscious, reasoning system two brain is unimpressed by the illogical connections we see in ads.

I'm sure they're not all Robinson Crusoe, but economists often show signs of having two-track minds. They believe certain things intellectually, but these beliefs don't seem to have the effect on their behaviour that you'd expect.

For instance, when you criticise their model for its absurd assumption that people are always rational - carefully calculating and self-interested - they'll tell you they don't actually believe people are rational; that's just a convenient assumption needed to get the model going.

But then they'll argue vigorously for propositions that come from the model, oblivious to the way those propositions rest on the assumption that people are indeed rational in all they decide.

Or, take the exaltation of gross domestic product. When you argue that GDP is a poor measure of national well-being and point out its various limitations, economists will agree. But that won't stop them continuing to treat GDP is though it's the one thing that matters.

One of the most ubiquitous problems in daily life - and thus in the economy - is one the economists' model assumes away: achieving self-control. We need to control our natural urges to eat too much, to smoke, to drink too much, to gamble too much, spend too much, watch too much television, get too little exercise and even to work too much.

Here, again, we seem to have two selves at work: an unconscious self that's emotional and shortsighted and a conscious self that's reasoning and farsighted. We have trouble controlling ourselves in circumstances where the benefits are immediate and certain, whereas the costs are longer-term and uncertain.

When you come home tired from work, for instance, the benefits of slumping in front of the telly are immediate, whereas the costs - feeling tired the next day; looking back on your life and realising you could have done a lot better if you'd got off your backside and played a bit of sport, sought a further qualification at tech, studied harder for exams, spent more time talking to your children, etc - are not so clear-cut.

Similarly, the reward from eating food is instant whereas the costs of overeating are uncertain and far off: being regarded as physically unattractive, becoming obese, becoming a diabetic, dying younger, etc.

As everyone who has tried to diet, give up smoking, control their drinking, save or get on top of their credit card debt knows, it's hard to achieve the self-control our conscious, future-selves want us to achieve.

People have developed many strategies to help their future-selves gain control over their immediate-selves, including pre-commitment devices - similar to those proposed by the Productivity Commission to assist problem gamblers.

Economics will become a more useful discipline when its practitioners catch up with developments in neuroscience and offer us solutions to common behaviour problems it now assumes away.

You're not as ethical as you think

2011-10-01T09:06:00.001+10:00

Another long weekend, another personal question: how honest are you? According to the people who study these things, not as much as you think you are.

In an experiment in which people were asked to solve puzzles and were paid a set amount for each puzzle they solved, some participants were told to check their answers against an answer sheet, count the number of questions answered correctly, put their answer form through a shredder, report the number of questions they got right to the experimenter and receive the money they had earned.

A second group wasn't allowed to shred their answers before reporting how many they got right. Those whose claims about how many they got right couldn't be checked claimed to have got significantly more correct than the second group.

Those who cheated probably counted a problem they would have answered correctly if only they hadn't made a careless mistake. Or they counted a problem they would have got right if only they'd had another 10 seconds.

In other words, they didn't tell blatant lies, they just gave themselves the benefit of any doubt, bent the rules a little bit in their own favour. And get this: they wouldn't have thought they were cheating.

When subjects are asked to rate how ethical they are compared with other people on a scale of 0-100, where 50 is average, the average rating is usually about 75. That is, almost all of us consider ourselves to be more ethical than other people.

Clearly, that's not possible. In their book, Blind Spots, Max Bazerman, a professor of business administration at Harvard Business School, and Ann Tenbrunsel, a professor of business ethics at the University of Notre Dame, say most of us behave ethically most of the time.

Even so, most of us overestimate our ethicality relative to others. We're unaware of the gap between how ethical we think we are and how ethical we actually are. We suffer from blind spots.

Bazerman and Tenbrunsel are exponents of the emerging field of ''behavioural ethics'' - the study of how people actually behave when confronted with ethical dilemmas. They say our ethical behaviour is often inconsistent and, at times, even hypocritical.

''People have the innate ability to maintain a belief while acting contrary to it,'' they say. ''Moral hypocrisy occurs when individuals' evaluations of their own moral transgressions differ substantially from their evaluations of the same transgressions committed by others.''

Hypocrisy is part of the human condition; we're all guilty of it. So you could say accusing someone else of being hypocritical is itself a hypocritical act.

Some people are consciously, deliberately unethical. But Bazerman and Tenbrunsel stress their interest is in unintentional ethical misbehaviour. How can we behave unethically and not realise it?

We suffer from ''bounded ethicality'' because we suffer from ''bounded awareness'' - the common tendency to exclude important and relevant information from our decisions by placing arbitrary and dysfunctional boundaries around our definition of a problem.

One way we limit our awareness is by making decisions on the basis of the information that's immediately available to us - maybe that someone has presented to us - rather than asking what information would be relevant to making the best decision, including other aspects of the situation and other people affected by it.

An organisation's ethical gap is more than just the sum of the ethical gaps of its individual employees, the authors say. Group work, the building block of organisations, creates additional ethical gaps.

Goupthink - the tendency for cohesive groups to avoid a realistic appraisal of alternative courses of action in favour of unanimity - can prevent groups from challenging questionable decisions.

And functional boundaries can prevent individuals from viewing a problem as an ethical one. Organisations often allocate different aspects of a decision to different parts of the organisation.

''As a result, the typical ethical dilemma tends to be viewed as an engineering, marketing or financial problem, even when the ethical relevance is obvious to other groups,'' the authors say. So everyone can avoid coming to grips with the ethical issue by assuming someone else is dealing with it.

Now consider this. You're a 55-year-old and have just been diagnosed with early-stage cancer. You consult a surgeon, who wants to operate to try to remove the cancer. You consult a radiologist who recommends blasting the cancer with radiation. You consult a homeopathic doctor who believes you should use less intrusive medicine and wait to see how the cancer develops.

Many of us would assume each specialist is lying so as to drum up business. But it's actually more complicated. Each person genuinely believes their treatment to be superior, but they fail to recognise their beliefs are biased in a self-serving manner.

They don't realise their training, incentives and preferences prevent them from offering objective advice. They just don't realise they're facing an ethical dilemma. They don't see they face a conflict of interest because they view conflicts of interest as problems of intentional corruption.

Bounded ethicality occurs because our cognitive limitations - the limitations of the way our brains work - leave us unaware of the moral implications of our decisions. Aspects of everyday work life - including goals, rewards, compliance systems and informal pressures - contribute to ''ethical fading,'' a process by which ethical dimensions are eliminated from a decision.

It's common for decisions at work to be classified as a ''business decision'' rather than an ''ethical decision,'' thus increasing the likelihood we will behave unethically.

Sometimes differences in language allow ethical fading. Albert Speer, one of Hitler's ministers and trusted advisers, admitted after the war that by labelling himself an ''administrator'' of Hitler's plan he convinced himself that issues relating to the treatment of people were not part of his job.

Why does the way we classify decisions matter? Because classification often affects the decisions that follow. When we fail to recognise a decision as an ethical one, whether due to our own cognitive limitations or because external forces cause ethical fading, this failure could well affect how we analyse the decision and steer us towards unintended, unethical behaviour.

Why do we predict we will behave one way and then behave another way, over and over throughout our lives? General principles and attitudes drive our predictions; we see the forest but not the trees. As the situation approaches, however, we begin to see the trees and the forest disappears.

Our behaviour is driven by details, not abstract principles.

Pinned down by fear of possibilities, not outcomes

2011-09-28T08:21:00.000+10:00

It's not something economists emphasise. Indeed, they prefer not to think about it because it reminds them of the limits of their so-called science. But the peregrinations of the economy are as much about psychology - moods and feelings - as tangible economic forces.

When you view the economy from outside, what you see is might and power.

Big corporations with towering offices, branches in every suburb, huge factories, gleaming shopping complexes, thousands of employees, annual turnover of hundreds of millions of dollars.

Then you have the big governments supposedly running the show. The federal government spending a budget of $360 billion a year.

The Reserve Bank moving interest rates up, or down, at will. The total value of all the goods and services Australia produces in a year is $1.4 trillion.

And against all that is me or you. No wonder we feel like pawns in a huge game, pushed this way and that by forces beyond our control.

But, last week, a student reminded me how bizarre it is that the world economy is built on something as nebulous as ''confidence''.

We may be as insignificant as ants, but when enough of us push in the same direction, we can make the global economy tremble. Take banks. They accept deposits from people who are free to withdraw their money at will, but then they lend that money to someone for 25 years.

So were it not for government protections, a run of depositors demanding their money back could bring the mightiest bank crashing down. When people see a queue forming outside a bank, all their instincts tell them to join it.

Take the sharemarket. If people are keener to sell a company's shares than to buy them at any moment, down comes the price - and, if it's one of our big companies, the retirement savings of people across the land take a dip.

If a company's shares fall, or if shares fall generally, the chances increase that the next move will be down rather than back up.

Take consumer confidence. When the economy looks like it's slowing and people worry about the possibility of losing their job, they postpone taking on new commitments and cut their spending on inessentials, just to be on the safe side. If enough people think and act that way, their fears become self-fulfilling and a self-reinforcing cycle develops.

Their reduced spending causes businesses to lay off staff, news of this causes others to become more precautious, and this, and the greatly reduced spending of the jobless, prompts another round of job losses and belt-tightening.

Our being social animals - our moods and actions are heavily influenced by the moods and actions of the people around us - means these swings easily develop momentum.

They work in both directions, of course. When we're confident, we spend, move to bigger or better homes and push up share prices with gay abandon.

When things are on the up, we can't imagine they'll ever stop rising; when things are heading down, we can't imagine they'll ever stop falling.

These swings in consumer confidence are matched by swings in business confidence. Business people take their lead from consumers, but they're just as susceptible to the mood swings of their own class.

The availability of credit amplifies these swings.

Households and businesses borrow heavily to take advantage of the good times, get ahead of rising property prices and keep the party going. On the way down, their high levels of debt add to their fears, caution and cuts.

So the economy is driven by alternating waves of excessive optimism and excessive pessimism.

At all times it looks terribly tangible, huge and inscrutable. But the booms and slumps are being driven by the nebulous moods and feelings of the human animal. Note, it doesn't matter whether the fears that set off these chains of adverse developments - runs on banks, falls in share prices, loss of consumer confidence - are well-founded or ill-founded.

Their consequences are real, regardless of their origins.

Adding to the insecurity and uncertainty - especially at times like these - is one of the hallmarks of the human animal, our insatiable curiosity.

We always want to know what's happening, why it's happening, how the world works and what the future holds.

The economies of Europe have serious debt problems. They've been grappling with those problems for months without resolving them.

We have no idea how well or badly this episode will end, nor even when. But every other week the world's financial markets suffer another bout of nerves and drop share prices further.

This increases the pressure on Europe's politicians to find a solution, but probably also increases the likelihood of disaster.

Every time our shares take another dive, the saga moves to the media's centre stage and they attempt, yet again, to explain its complexities and ask more experts to predict how things will turn out.

Our crazy, unceasing urge to ask people who can't know to speculate about what the future holds arises from what psychologists call our ''illusion of control'' - our tendency to overestimate our ability to control events.

We want to know all about the events in Europe and elsewhere and how they will affect us because ''forewarned is forearmed'', and just in case there is something we can do to protect ourselves.

In truth, however, the main thing we are doing is putting the wind up ourselves long before it is possible to know what will happen and how seriously it will affect us in Australia.

My guess is, what will hurt us most is our fear of the possibilities, not the ultimate events.

The trouble with moods and feelings is their ability to influence hard economic facts.

Memo bosses: happier staff work better

2011-09-26T09:26:00.000+10:00

In the quest to lift the flagging productivity of labour, we can go back to old, failed ideas or move on to new ones. Last week Peter Reith came out of retirement to urge the Liberals to get tough with workers and reopen class warfare.

Want to get more out of your workers, make them work at unsociable hours for normal hourly rates, keep wage rises tiny or simply whittle away at their conditions? Re-introduce statutory individual contracts and split workers off from their union so they lose all bargaining power.

Does this mean you spend most of the year negotiating one-on-one with your employees because Mary wants to leave early on Mondays, Jenny and Julie want to job-share and Bill wants time off to do a tech course?

Hell, no. That's just the advertising. In reality you get your lawyer to cook up a single contract document that runs all your way and tell each of your employees to feel free to leave if they don't want to sign.

It's a good way to minimise wage costs if you don't mind having a surly, resentful staff, if they're supervised tightly enough for you to be confident they won't be able to find ways to get back at you, if they're mainly unskilled and if unemployment is high.

But if their work is skilled, if you need them to accept a high degree of responsibility with limited supervision, if there are shortages of skilled labour and rival employers are on the poach, it's a great way to damage a good business.

I'm sure there are second-rate business people urging the Libs to restore their former ability to screw their workers with impunity, but I hardly think it's the way to a brighter, more productive future.

The first stage of employer enlightenment comes when they seek to improve employees' performance with monetary incentives: merit increases to selected workers, bonuses or other forms of performance pay.

This approach makes sense to model-bound economists and money-minded executives, but industrial psychologists know it often backfires. Workers do care about pay, but they care less about the absolute level of their pay than about its relative level - that is, what they're getting compared with others are getting, particularly those they consider their equals. In other words, play favourites with pay and you're just as likely to create dissatisfaction as satisfaction.

The other thing to remember (which many economists and business people don't) is that when you establish a culture that good performance is rewarded with money, you tend to demotivate people from performing well for other, more intrinsic reasons. You debase the currency, so to speak.

What never occurs to second-rate managers - the sort of managers who run to politicians for legal solutions to their inadequate relationships with their workers; the sort who never reach the ultimate stage of human-relations enlightenment - is that most workers want to work in an environment in which they can trust their bosses and be trusted by them, where they can give and receive loyalty.

Why wouldn't you want to work in such an environment? Recent research by two Canadian economists, John Helliwell, of the University of British Columbia, and Haifang Huang, of the University of Alberta, shows that life satisfaction - happiness - is significantly higher among workers who work where they rank management trustworthiness highly.

For example, the roughly one quarter of surveyed workers who rated trust in management at nine or 10 on a 10-point scale also rated their satisfaction with life at 8.3 on a 10-point scale, compared with an average of 7.5 for the quarter or more who rated trust in management at five or below.

And, get this: for the whole sample of workers, a change in trust in management of just 0.7 points had the same effect on life satisfaction as a 31 per cent change in income. But why should a hard-headed manager care about the happiness of the people working for them?

Well, one reason is that, unless managers are money-hungry to a quite inhuman extent, they themselves would get more satisfaction being the boss of an outfit where everyone gets on and pulls together.

Even a manager should see there is more to life than money (and, please, spare me the sermon about how corporation law requires you to maximise profits for the shareholders). But, if that's not a good enough argument for you, try this: longitudinal research finds that happier people tend to be more successful in all dimensions of their lives - their incomes, their careers, their health and their relationships.

It's not hard to believe successful people are happier, but this is saying the reverse: being of a happier disposition tends to make people more successful. More specifically, happy workers make more money, receive more promotions and better supervisor ratings, and are better citizens at work.

So, if employers want to offer a satisfaction-inducing working environment, what must they do? The British psychologist Peter Warr has identified five factors as important to job satisfaction. First, opportunities for personal control. This means having some discretion - autonomy - in how to tackle problems, apply skills and envisage outcomes.

Second, jobs with a variety of tasks. Many jobs are naturally varied but highly repetitive jobs are soul-destroying. When workers work in teams, roles can be shared.

Third, good supervisors provide a balance of freedom and supervision. The ideal ratio of positive to negative feedback is about six to one.

Fourth, jobs that afford people respect and status are likely to engender feelings of competence and pride. In the best organisations, the respect that is inherent in some high-status jobs can be extended to all jobs.

Finally, have clear requirements and information on how to meet the requirements.

Retail despair as consumers spurn goods for services

2011-09-24T09:12:00.000+10:00

There's a bumper sticker that says: if you think money doesn't buy happiness, you don't know where to shop. It's just a joke. But there's actually a bit of science in it. Research by psychologists says buying stuff doesn't bring us as much satisfaction as buying experiences - such as a holiday or even a restaurant meal.

Experiences are more satisfying than goods because they leave us with memories to think over (which we often enhance by forgetting the bad or boring bits) and give us something to talk about with our friends. And, after all, what are we but the sum of our experiences?

Experiences are services rather than goods and it's possible Australians are taking the psychologists' findings to heart because, as Dr Philip Lowe of the Reserve Bank pointed out in a speech to the Australian Economic Forum this week, consumers have been switching their spending towards services and away from goods.

The Bureau of Statistics' household expenditure survey shows that, over the quarter century since 1984, the proportion of household spending devoted to food felLby more than 3 percentage points to just 16.5 per cent.

The proportion devoted to clothing, footwear, household furniture and appliances fell from about 14 per cent to just over 8 per cent. Similarly, the share going to spending on alcohol and tobacco dropped by almost 1.5 percentage points to less than 4 per cent.

Over that period we're also spending smaller proportions of our budgets on cars and petrol and - get this - fuel and power, the latter of which now accounts for less than 3 per cent of the average household's budget.

But if we're devoting smaller shares to all those things, what things are getting bigger shares? Top of the list is housing, which is up from less than 13 per cent to 18 per cent. That includes people who are renting as well as people with mortgages and people who've paid off their mortgages.

We're also devoting higher proportions to spending on healthcare, education, household services (including childcare, cleaning, lawn mowing and gardening) and recreation (including audiovisual equipment, toys, sporting goods, pets and holidays).

As you see clearly from all that, we're devoting less of the consumer dollar to goods and more to services. While our politicians are giving speeches about the need for Australia to ''make things,'' we're busy making it a place that ''does things''.

This trend's been running for many moons but why? Long story. The first thing to remember is that just because we're devoting a smaller share of our budgets to food, clothing and footwear doesn't mean we're starving ourselves and running round barefoot and naked. It's not that we're spending any less on goods, it's that our spending on services has been growing faster than our spending on goods, thereby reducing goods' proportion of the total.

Part of the reason services' share is up is that the prices of services are rising faster than the prices of goods. That's because it's easier to increase the productivity of labour in the production of goods. People keep inventing ever-better labour-saving equipment, which allows the prices of manufactured goods to stay fairly stable or, in some cases, actually fall.

Many of the manufactured goods we buy are imported and the prices of imported manufactures are being kept low by various factors over the years: by increased competition from China and other Asian developing countries putting downward pressure on the world prices of many manufactures, by the phasing down of protection for domestic producers of clothing, footwear and cars, and lately by the higher dollar.

In marked contrast, services tend to be more labour-intensive, with less scope for better machines to increase the productivity of labour. Even so, real wage rates in the services sector tend to keep pace with the improvement in economy-wide productivity (most of which comes from the other sectors).

But though it's true we're spending more on services because their prices are rising faster, it's also true the quantity of services we're buying is rising faster than the quantity of goods we're buying. As real household income increases over time we have to spend the extra income on something, but there's a limit to how much more we can eat, how many clothes we can wear and cars and fridges we can use. By contrast, we're well short of the limit on the things we'd like to pay other people to do for us as we get more able to afford it. Enterprising businesses keep thinking of new things to do for people.

A ''superior good'' is one to which we devote a higher proportion of our spending as our income grows. And most superior goods are, in fact, services. Healthcare and education are superior goods, as is recreation and ''meals out'', as the bureau calls them.

But the glaring case in recent times is housing. Its share of our budgets has risen by more than 5 percentage points, with most of that occurring in the past decade. The reason is not higher mortgage interest rates - they go up and down - but higher house prices and bigger mortgages, thus leading to higher interest payments.

As an individual, you may think you had little choice but to pay the higher house prices. But what's true for the individual isn't true for the whole. House prices have risen so much because all of us bid them up in our (largely futile) efforts to use our higher disposable incomes to buy better housing.

That explains the long-term trend towards services and away from goods. But, as Lowe pointed out, over just the past year, the trend's become supercharged. According to the national accounts, real consumer spending over the year to June rose by 1.75 per cent for goods, but about 4 per cent for services.

Consumer spending on education services was up by 5 per cent, on hotels, cafes and restaurants by more than 6 per cent, on recreation and culture by 7 per cent, and on ''transportation services'' by 16 per cent. This last is mainly people taking cheap overseas holidays. (Other research shows that even people on lower incomes are spending more on holidays.)

So now you know why the retailers - who sell goods, not services - are doing it so tough but, despite widespread misapprehension, overall consumer spending is growing fine.

Sydney too must go up to go green

2011-09-21T10:52:00.002+10:00

As a denizen of the inner city, I love getting away to the countryside. Away from the tar and cement and exhaust fumes to the trees and grass and clean air. In the country or on the coast you feel closer to nature, leading a simpler, cleaner life, doing less damage to the environment. I always feel that, being more natural, trees and grass are good for the spirit.

So it comes as a bit of a shock to read in Triumph of the City, the latest book by America's leading urban economist, Professor Edward Glaeser, of Harvard, that cities are a lot greener than the suburbs and countryside.

''Cities are much better for the environment than leafy living,'' Glaeser says. ''Residing in a forest might seem to be a good way of showing one's love of nature, but living in a concrete jungle is actually far more ecologically friendly.

''We humans are a destructive species, even when ? we're not trying to be. We burn forests and oil and inevitably hurt the landscape that surrounds us. If you love nature, stay away from it.''

We could minimise our damage to the environment by clustering together in high-rises and walking to work, he says. We maximise our damage when we insist on living surrounded by greensward. Lower densities inevitably mean more travel, and that requires energy. While larger living spaces certainly have their advantages, large suburban homes also consume much more energy.

Anyone who believes global warming is a real danger should see dense urban living as part of the solution. Over the next 50 years, China and India will cease to be poor rural nations, and that's a good thing. They, like the West before them, will move from farms to urban living.

''If billions of Chinese and Indians insist on leafy suburbs and the large homes and cars those suburbs entail, then the world's carbon emissions will soar ? The critical question is whether, as Asia develops, it will become a continent of suburban drivers or urban-transit users.''

Historically, the wealthy managed to combine city and country living by having two homes. Winter months were spent in the city, while hot summers were spent on the country estate.

Less expensive solutions were to surround towns and cities with a green belt. Failing that, big city parks were established. But the emergence of faster, cheaper transportation made it possible to live with trees and work in the city.

Homes and cars account for about 40 per cent of the average American household's emissions of carbon dioxide, half of which is attributable to cars. People could buy more fuel-efficient cars, but the big difference is whether you drive 500 kilometres a year or 50,000, which depends on whether you live in a city or a suburb. Cities are also greener than suburbs because city households use less electricity.

''Smart environmentalism requires thinking through the inadvertent side-effects of different environmental policies and recognising those that actually do more harm than good,'' Glaeser says. The conservationists who keep the San Francisco Bay area free from new construction are preventing development in the greenest part of America. They are consequently increasing development in America's browner areas, such as baking-hot, air-conditioned Texas.

''In older cities like New York, NIMBYism hides under the cover of preservationism, perverting the worthy cause of preserving the most beautiful reminders of our past into an attempt to freeze vast neighbourhoods filled with undistinguished architecture.

''In highly attractive cities, the worst aspects of this opposition to change are that it ensures that building heights will be low, new homes will be few, prices will be high, and the city will be off-limits to all but rich people.''

People seem surprisingly ignorant of how supply and demand work. When the demand for a city rises, prices will rise unless more homes are built. When cities restrict new construction, they become more expensive.

Cities grow by building up or out. When a city doesn't build, people are prevented from experiencing the magic of urban proximity. Preserving a city can, in fact, require destroying part of it, Glaeser says.

The modern desire to preserve Baron Haussman's Paris has helped turn the affordable Paris of the past - with its history of impecunious but ultimately celebrated artists - into a boutique city that today can be enjoyed only by the wealthy.

There is great value in protecting the most beautiful parts of our urban past, but cities shouldn't be embalmed in amber. Too much preservation stops cities from providing newer, taller, better buildings for their inhabitants.

Height restrictions - in Paris, New York and Mumbai - should be of interest and concern to far more of us than just the planning professionals. ''These rules are shaping the future of our cities and our world,'' Glaeser says. ''If the cities' history becomes a straitjacket, then they lose one of their greatest assets: the ability to build up.''

Height, he says, is the best way to keep prices affordable and living standards high.

Glaeser's observations seem of obvious relevance to Sydney and the decisions facing the O'Farrell government. Our sky-high house and unit prices are partly the product of strong demand being met by a woefully inadequate supply of additional houses and units. Now those high prices are contributing significantly to Sydney and NSW's weak rate of economic growth.

The lack of additional supply comes partly from our topography, but mainly from excessive government restrictions on development. But there are limits to how far Sydney can be allowed to sprawl - including the inadequacy of public transport.

Sydney needs to go up, and part of that up is more medium-density housing in north shore Liberal electorates, including the Premier's own.

New budget office must clarify, not confuse

2011-09-19T12:17:00.002+10:00

Economists believe people should be judged by their ''revealed preference'' - by what they do, not what they say. If so, Wayne Swan is supremely confident Labor will romp home at the next election, whereas Joe Hockey is not at all sure the Liberals will win this time round.

You can deduce this from the different positions the two men take on the legislation to establish a parliamentary budget office. Swan has presented a bill that offers tightly defined benefits to the opposition of the day, whereas Hockey wants to give oppositions a much wider licence to argue the toss with the government. Both seem to be ''taking no thought for the morrow''.

The idea of a parliamentary budget office - roughly modelled on the independent US Congressional Budget Office - has potential to greatly improve the quality of the debate about how much election promises would cost and how they'd be paid for, imposing greater discipline on the parties.

Peter Costello's charter of budget honesty was intended to bring this about by giving both sides the ability to have their policies costed by Treasury and the Department of Finance during the election campaign. But Costello biased the rules against the opposition of the day, meaning they have proved unworkable. The present arrangements require the heads of Treasury and Finance to publish in their own name a pre-election economic and fiscal outlook - giving revised forecasts for the economy and the budget balance - soon after each election is called. No problem there.

It also allows both sides to submit their announced policies to Treasury and Finance for costing. These costing are published by the two departments as soon as they are done. This is fine for governments, which are able to privately bombard the departments with requests to cost a host of possible policies before the election is called. In a process of iteration, treasurers are able to refine their proposals in the light of advice about what things will cost and alternative ways of skinning the cat.

Then, once the election's called, they announce their policies and bowl them up to be ticked by the same people who costed them in the first place.

But oppositions get no pre-election access to the econocrats to try out different proposals. They have to painstakingly gather facts about the cost of this and that, or spend a fortune paying Canberra consultants to cost their policies, knowing those consultants can't necessarily do it the way Treasury does it - especially so after Access Economics retired hurt from the game, having been monstered once too often by the lovely Costello.

The problem is that if Treasury and Finance judge the opposition's costing to be wrong - as there's a high chance they are - this is announced during the campaign and the treasurer carries on about the incompetence and irresponsibility of his opponents.

Swan's bill follows the unanimously agreed recommendations of a multi-party committee. The office would be established as a department of the Parliament, independent of the government. It would give all non-government members the ability to have policy proposals costed in a private, iterative process until the start of the campaign.

The costings for policies submitted during the campaign would be automatically made public. This would put the opposition on the same basis as the government, provided the office had adequate access to the unique information base and costing models used by Treasury and Finance.

It would give the Greens and independents access to accurate costing for the first time, a big step forward. The office would be required to use the same economic forecasts, budget parameters and costing conventions as Treasury and Finance, which would put all costings on a comparable basis and mean the costings used by an opposition during a campaign were essentially the same as those Treasury would incorporate into the budget should the opposition become government.

The office would not have the power do its own forecasts, nor undertake modelling of the economic (as opposed to budgetary) consequences of possible policy reforms.

But Hockey has proposed amendments to the government's bill to give the office a wider range of powers. It would have the same powers as the Auditor-General to demand information of government departments. It would be able to use different forecasts and costing conventions to those in the budget.

Non-government members would be able to have confidential dealings with the office even during election campaigns, making their own decisions about whether and when to make costings public. The Gillard government's funding allocation for the office - about $6 million a year for four years - would be indexed to Treasury's funding.

These Liberal counter-proposals demonstrate a degree of mistrust of governments - and governments' ability to interfere with Treasury forecasts and budget estimates - that seems common among oppositions but is unwarranted.

Not since the Hawke-Keating government have governments interfered in Treasury's economic forecasts and budget figurings. Treasury's forecasts are often wrong and even its costings can prove astray, but there's no reason to believe any other outfit could do better. I think it fair enough to require oppositions to get their policies decided and costed before the campaign starts, just as the caretaker convention requires governments to.

If the taxpayer has to pay for an additional costing body it's vitally important the work of this body helps to clarify the debate not make it even more confusing than it already is.

It's infinitely preferable that all parties' costings be prepared on the same basis, rather than allowing oppositions to chose different economic forecasts or different budget parameters and costing conventions.

If we can avoid that tower of Babel the parliamentary budget office will be a big improvement.

Thrift paying big dividends on current accounts

2011-09-17T08:18:00.000+10:00

The nation's econocrats have been pondering the resources boom for years, but one thing they've been expecting isn't coming to pass: we're not getting huge deficits on the current account of the balance of payments.

Last week's figures showed a deficit of just $5.3 billion for the June quarter, about half what it was in the March quarter. This included a surplus on the balance of (international) trade in goods and services of

$7.5 billion - the fifth quarterly surplus in a row - offset by a deficit on net income payments (our payments of interest and dividends to foreigners less their payments to us) of $12.8 billion.

Switching to the year to June, the current account deficit was $33.6 billion, down from $53.3 billion the year before. Expressed as a proportion of gross domestic product, this was an amazingly low 2.4 per cent, down from 4.1 per cent the year before.

So why were the econocrats expecting bigger deficits? Because most of the money to finance the surge of investment in new mines and natural gas facilities would have to come from foreigners, thereby adding to the surplus on the capital account of the balance of payments which, with a floating currency, is always exactly balanced by a deficit on the current account.

And why haven't the big deficits come to pass? Because household saving has been a lot greater than the econocrats were expecting. The more the nation saves, the less it has to call on the savings of foreigners to finance its investment spending.

Last financial year's current account deficit is down because saving is up while the mining investment boom is only just getting started.

As that boom gets under way, the current account deficit is likely to grow. This year's budget forecast a deficit of 4 per cent of GDP for this financial year, rising to 5.25 per cent in 2012-13. Even so, those figures are smaller than the econocrats had been expecting before they realised how much more households were saving.

Last week's national accounts showed households saving a net (that is, after allowing for the year's depreciation in the value of household assets) 10.5 per cent of household disposable income. This is unlikely to be an aberration; it's more likely to be a reversion to our earlier thrifty habits.

If you're more used to thinking about the current account deficit in terms of exports and imports, I should explain that these days economists tend to look on the other side of the coin, which shows saving and investment.

The current account deficit equals the capital account surplus, which represents the net inflow of foreign financial capital to the Australian economy. As we've seen, we call on the savings of foreigners to finance that part of our investment in new physical capital than can't be financed by our own saving.

This net inflow of foreign financial capital allows us to import more goods and services than we export, including imports of capital equipment.

The net capital inflow also helps us finance our net payments of interest on the nation's net foreign debt and our net payments of dividends on net foreign equity investment in Australia's businesses - though the ultimate justification for our foreign borrowing is the profits we make from our physical investments.

The nation's annual investment spending includes not just business investment in equipment and structures, but also public investment in infrastructure and households' investment in the construction of new homes.

Similarly, the nation's annual saving includes not just the amount saved by households, but also the saving companies do when they retain part of their after-tax profits rather than paying them all out in dividends and the saving governments do when they raise more in revenue than they need to cover their recurrent spending.

According to an article in the federal Treasury's latest Economic Roundup, in the decade or so before the first stage of the mining boom began in 2003, the current account averaged 3.7 per cent of GDP. During the first stage it averaged 5.7 per cent, but since the global financial crisis it's averaged 3.3 per cent.

Before the mining boom, gross national investment spending (that is, before allowing for the annual depreciation of assets) averaged 24.3 per cent of GDP. Since the start of the mining boom it's averaged 27.9 per cent.

Had the level of gross national saving stayed unchanged, that would have increased the average current account deficit by 3.6 percentage points. In fact, national saving has increased from 22.2 per cent to 24.5 per cent.

While households have been saving a lot more in the period since the global financial crisis, federal and state governments have fallen into operating deficit, meaning they've gone from saving to dissaving. As they get their budgets back to operating surplus in the next year or two they'll be adding to rather than subtracting from national saving.

Company profits have been high in recent years and many companies have been saving a fair bit. Mining companies, in particular, have been reinvesting a lot of their after-tax profits in expanding their activities. (To the extent that those retained earnings are owned by foreign shareholders, and were initially counted in the balance of payments as capital outflows, their reinvestment is counted as foreign capital inflow, even though the actual dollars never left the country.)

Australia's persistent current account deficit has always reflected a high rate of national investment rather than a low rate of national saving. Although our household saving rate was quite low during the decade or so to the mid-noughties, our overall, national rate of saving has been around the average for the developed economies.

Point is, should our current account get a lot bigger in the next few years, it will be because the mining construction boom involves a lot more investment spending, not because we're saving less.

We've done much hand-wringing lately about ''the cautious consumer'' (especially when we imagined consumer spending was weak, which we learnt last week it isn't), but the fact that increased household saving has stopped the strong growth in household income translating into booming consumer spending has some big advantages.

If we can avoid a consumption boom occurring at the same time as an investment boom, the Reserve Bank won't need to increase interest rates as much to control inflation and this, in turn, will avoid adding upward pressure to the Aussie dollar.

Terrorism. A vast cost of feeling a little more secure

2011-09-14T09:53:00.000+10:00

Now the 10th anniversary of the terrible events of September 11, 2001, has passed, it's time for plain speaking.

You've often seen me criticise economists for their bloodless rationalism - their excessive focus on efficiency in the satisfaction of our material wants and neglect of our emotional and social needs. Yet it's possible to go too far the other way, to be too emotional and not sufficiently hard-headed in our reaction to events.

And that's just what we've been in our response to the destruction of the World Trade Centre towers. We've exaggerated the threat from terrorism and spent far more than is sensible in trying to reduce it.

As usual, we have better information on the Americans' response than on our own, similar response. But there's much to learn from a study of the American experience by John Mueller, a professor of national security studies at Ohio State University, and Mark Stewart, a professor of civil engineering at our own University of Newcastle.

In the months after September 11, it was almost universally assumed the events represented not an aberration but the start of a new era of greatly increased terrorist threat. Intelligence sources estimated there were as many as 5000 al-Qaeda operatives in America.

So, like we did, the Americans hugely increased their spending on security. They established a new Department of Homeland Security and, in the time since then, increased spending on homeland security by a cumulative $US360 billion ($348 billion). They increased spending on federal intelligence by a cumulative $US110 billion, while state and local governments increased their spending by the same amount. The private sector's increased spending on security measures is estimated to be similar.

All that totals $US690 billion. Now Mueller and Stewart add the opportunity costs of terrorism insurance premiums, passenger delays caused by airport screening, the value of lives lost because people drove to their destination rather than suffer airport delays, and other losses in consumer welfare.

That totals $US420 billion, taking the grand total additional cost since 2001 to well over $US1 trillion.

Those figures don't include the cost to US taxpayers of the terrorism-related wars in Iraq and Afghanistan. The equivalent figure for Australia (which does include the cost of the wars) is about $30 billion.

The question people often ask is, are we safer? That's a silly question. Of course we're safer. The posting of a single security guard at the entrance to one building makes us safer, if only microscopically.

The sensible question is, are the gains in security worth the amount we're paying? Or, in the words of one risk analyst, "How much should we be willing to pay for a small reduction in probabilities that are already extremely low?"

The fact is, despite the escalation in our fear of terrorism, and despite the considerable publicity given to cases where the authorities have foiled bungling terrorist intentions, there's been no great increase in terrorist attacks outside war zones.

In 2005, after years of well-funded sleuthing, the FBI and other investigative agencies admitted that they had been unable to uncover a single al-Qaeda sleeper cell anywhere in the US.

So any terrorist threat derives from small numbers of home-grown people, often isolated from each other, who fantasise about performing dire deeds and sometimes receive a bit of training and inspiration overseas.

Home-grown Islamist potential terrorists are estimated to represent one in every 30,000 Muslims in the US. Muslim extremists have been responsible for a 50th of 1 per cent of the homicides committed in the US since 2001.

Around the world, the number of people killed since 2001 by Muslim extremists outside of war zones is 200 to 300 a year. That's 200 to 300 people too many, of course.

But it's less than the number of people in the US who drown in bathtubs each year.

The increased delays at US airports because of new security procedures have prompted many people travelling short distances to drive rather than fly.

But driving is far riskier than air travel and the extra road traffic is estimated to result in 500 or more extra road deaths each year.

More than 100 Australians have been killed by terrorists since 2001. But all of them have been overseas, the majority in the Bali bombing of 2002. There have been no terrorist attacks in Australia, though our security agencies claim to have foiled four "mass casualty events".

Stewart says the risk of an Australian being killed in a terrorist attack is one in seven million each year, which is about the same as the risk of being struck by lightning.

Why have we spent such huge sums trying to reduce such a small risk? And why have governments paid so little attention to whether we're getting value for money, especially at a time when budgets are tight and so many worthier causes are going begging?

Partly because we demand it of them. As someone said, "we have come to believe that life is risk-free and that, if something bad happens, there must be a government official to blame". Apart from the desire of security forces and spooks to work in a growth industry, politicians face distorted incentives. It's safer to spend more and risky to spend less.

Osama bin Laden's stated goal in launching his attack and threatening more was to lead the US into bankruptcy. He didn't succeed, but he has provoked a reaction that's contributed significantly to the US government's severe budgetary problem, which seems likely to cripple the American economy for the rest of the decade.

Meanwhile, we're left with security measures at airports and elsewhere that do more to inconvenience the public than the terrorists and amount to little more than security theatre.

Rising unemployment more puzzle than worry

2011-09-12T09:30:00.002+10:00

The unemployment rate has risen by 0.2 percentage points for two months in a row. Taken at face value, that says the economy is rapidly heading into recession. But it's always a mistake to take economic statistics at face value and, fortunately, the truth is likely to be far more reassuring.

The trick to using economic indicators to understand what's happening in the economy is not to overreact to the latest reading from one indicator. The new figure has to be put into the context of the particular indicator's trajectory and the general message coming from all the indicators.

Some indicators are more important than others. The quarterly national accounts - the centrepiece of which is gross domestic product - are the most important because they constitute the summation of a host of ''partial indicators''. GDP may be a poor guide to the nation's overall well-being, but it's a good guide to the outlook for income and jobs.

The monthly figures for employment and unemployment are very important because that's one of the main things we expect the economy to do for us: generate jobs for all those who want them.

The next question to ask when you get a new reading from an indicator is: how reliable is it? The job figures are based on a rotating sample survey, meaning they're subject to sampling error (as well as a lot of opportunity for other, human errors).

They tend to bounce around from month to month for reasons you can never put your finger on, but which don't reflect the more stable reality of the labour market. The national accounts also bounce around and are subject to heavy revision as more reliable data come to hand.

So both the key indicators are a bit ropey, and economists often use one as a check on the other. We know from last week's national accounts that, though natural disasters caused the economy to go backwards in the March quarter, it bounced back strongly in the June quarter and will recover further over the rest of the year as flooded coalmines get working again.

Last week's jobs figures told us that national employment - which totals 11.4 million - fell by 4000 in July and 10,000 last month. These are trivial amounts; they're saying not that employment is falling, but just that it's not growing. Trouble is, we need employment to keep growing because the population of people wanting jobs keeps growing. We need employment to grow by about 10,000 a month just to hold the rate of unemployment steady. Fortunately, this is less than half the rate of employment growth we needed a year or two ago because the rate of growth in immigration is now so much lower.

Note, unemployment has risen not because people are losing their jobs, but because additional jobs aren't being created. As a general proposition, we need the economy to be growing steadily because that's what creates additional jobs. Stepping back to view a longer run of figures, we see that employment was growing very strongly until November, since when it's shown virtually no growth. Though the economy contracted sharply in the March quarter, this contraction was weather-related and concentrated heavily in mining. And, as we've seen, the economy grew strongly in the June quarter.

So the pattern of growth in employment isn't easily reconciled with the pattern of growth in production (GDP). We need to examine the jobs figures to see how robust they are.

One way to see if there may be problems with the rotating sampling process is to look at what's happening to the ''matched'' sample (the part of the sample that's unchanged from one month to the next). Kieran Davies, of the Royal Bank of Scotland, has done this and finds that ''smoothed matched-sample employment is growing at 17,000 a month, while headline employment is broadly flat''. Hmmm.

Examining the breakdown of the (headline) employment figures shows the weakness is heavily concentrated among men rather than women. It also shows the problem is concentrated in Queensland (where in two months the unemployment rate has risen 0.9 percentage points to 6.2 per cent) and Western Australia (where in one month the unemployment rate has risen 0.4 percentage points to 4.4 per cent).

I don't trust those figures. But if you take them literally, both they and the national accounts are saying the precise opposite to the conventional wisdom about the ''two-speed economy'': all the weakness is in mining and the mining states, while all the strength is in the so-called non-mining economy.

But here's another puzzle. While there's been no growth in the number of people employed this year, the total number of hours worked has been rising solidly, with average hours per worker rising from 34.7 to 35.6 hours a week.

As Davies has argued, this sort of behaviour by employers - where they work existing staff harder rather than employing more workers - is what often happens when the economy is recovering from a recession and the media is wringing its hands over ''jobless growth''. It may be that, fearing skilled labour shortages, employers stocked up with workers last year, but this year they're not hiring any more until they need to.

The forward indicators of employment (job ads, vacancies etc) are weaker than they were, but still not weak. And the outlook is for strengthening GDP growth over the rest of this year, with the Reserve Bank's forecast of 3.25 per cent growth over the year to December still in with a chance.

So whatever the job figures are telling us, it's not that we're sliding rapidly towards recession - even in the so-called non-mining economy.

A dose of reality for people who profit from doom

2011-09-10T09:26:00.000+10:00

It's good news week - rumours of the impending death of the economy turn out to be greatly exaggerated. The national accounts for the June quarter provide a salutary lesson on how far popular perceptions can drift from reality.

Three months ago we were told real gross domestic product contracted by 1.2 per cent in the March quarter. This week we're told the contraction was a quarter less than that: 0.9 per cent.

That contraction was fully explained by the temporary effect of floods and cyclones. This week the temporary nature of that setback was confirmed - the economy rebounded to grow by 1.2 per cent in the June quarter.

Note that part of this rebound is purely arithmetic: had the economy not gone down in the March quarter it wouldn't have come back up as much in the following quarter. So it would be mistaken to imagine the economy was travelling at the annualised rate of 4.9 per cent (roughly, 1.2 x 4) in the quarter.

Despite the clearly temporary nature of the contraction, it fed into an increasingly negative mood about the state of the economy. The retailers were doing it tough because consumers were worried about so many things - the carbon tax, interest rates, uncertainty about the North Atlantic economies - and so were saving rather than spending.

You could see this from the way the indicators of consumer confidence kept falling. As part of this consumer caution, not many people were buying new homes.

Then there were the manufacturers doing it tough and laying off workers because of the very high dollar.

In short, the miners and the mining states might be coining it, but all the rest of us in the ''non-mining economy'' were just about stuffed. Turns out most of that was nonsense. Some of it was true - the retailers and manufacturers are doing it tough and housing activity is weak - but those three sectors account for less than 20 per cent of the economy, not the 90 per cent that is the so-called non-mining economy.

The rest we imagined. The media did its usual thing of trumpeting the bad news and playing down the good news but this fell on unusually fertile ground, to mix a few metaphors. The Gillard government's doing a terrible job, therefore the economy's stuffed. That's logical, isn't it?

This week we got a bulletin from the real world. Turns out that though real retail sales grew by just 0.3 per cent in the quarter and 0.6 per cent over the year to June, real consumer spending grew by a healthy 1 per cent in the quarter and a bang-on-trend 3.2 per cent over the year.

Huh? How did we get it so wrong? Well, we took too much notice of the retail sales figures simply because they come monthly, forgetting they account for only about 35 per cent of total consumer spending.

Retail sales cover mainly goods - what they don't cover is mainly services. In recent times our spending preferences have shifted away from goods and towards services. When that happens, the retail sales figures give you a bum steer.

Our other mistake was to take too much notice of the fall in consumer sentiment. It proved a dodgy guide to actual consumer spending. Both these things have tricked us many times before.

The punters know no better and, though it pains me to admit it, the media have a vested interest in not querying a bad-news story. But there's no excuse for the business economists - for them it's professional incompetence. Proof they're not as rational as their model assumes all of us are and not impervious to the popular perceptions around them, as their model also assumes.

This week's figures also reveal a tiny fall in the rate of household saving to 10.5 per cent of household disposable income. Though the ratio is notoriously volatile, this raises the possibility that households have got their rate of saving up to where they want it.

This, in turn, raises another point of arithmetic - it's not a high rate of saving that causes weak growth in consumer spending, it's an increasing rate of saving. Once the rate has stabilised, consumption must grow as fast as household disposable income is growing.

And despite all the phoney I-know-you're-doing-it-tough rhetoric coming as both sides of politics feed back the whinges they hear from their focus groups, the accounts confirm household income is growing particularly strongly - by a nominal 7.5 per cent over the year, way ahead of inflation.

That strong growth comes from a combination of healthy growth in employment (more household members with jobs) and somewhat excessive growth in real wages given our weak rate of productivity improvement.

Both factors are evidence most of us aren't doing it tough.

Part of the narrative of the resources boom is that growth will come more from business investment spending (as we build a lot more mines) than from consumer spending. That wasn't true this quarter. Why not? Not because business investment was weak - it wasn't - but because consumer spending was both strong and accounts for a much bigger share of GDP than investment does.

The other side of the non-mining-economy-is-stuffed proposition is that pretty much all the growth in the economy is coming from the mining sector. As a general proposition, there's no doubt the mining, mining-related and heavy construction industries are growing strongly. But, according to the accounts, that wasn't true in the June quarter. As Kieran Davies, of the Royal Bank of Scotland, has pointed out, with the output of mining proper going backwards during the quarter, the output of the so-called non-mining economy grew by 1.3 per cent, more than accounting for the growth of 1.2 per cent overall.

That's the bit people have convinced themselves is stuffed.

Why isn't mining growing? Because a lot of the flooded Queensland coalmines are still not back to production. But this, of course, is temporary. As they come back on line in the second half of this year they'll give GDP a one-off boost.

You have to be careful not to read too much into the quarterly national accounts, which are subject to frequent revision.

But you have to be even more careful not to be misled by those who cry loud and long about how tough things are. They're probably exaggerating (or being exaggerated by a bad-news obsessed media) while those who are doing fine say nothing.

THE DUMBING DOWN OF THE PUBLIC POLICY DEBATE

2011-09-08T10:07:00.001+10:00

Gruen Lecture series, Australian National University
September 8, 2011

I’m delighted to be taking part in this lecture series to honour my old friend Fred Gruen. I still regret his passing, even though his two sons just about fill the vacuum he left.

Oldies have always lamented that things aren’t as good as they used to be, but I don’t think there’s any reason to doubt the widespread perception that the debate - or ‘discourse’ as the fashionable academics say - about politics and public policy has become a lot less intellectually satisfying. If Fred were to come back and take up today’s newspapers, I don’t doubt he’d notice the difference. It’s got worse since the arrival of the Rudd-Gillard government, and worse again since Tony Abbott became opposition leader. But I suspect it would be a mistake to attribute too much of the deterioration to the actions of particular individuals. And, in any case, I’m sure the rot set in a lot earlier than 2007 or 2009. We’re dealing with a deteriorating trend that has been running for many years.

I could regale you with the worst examples of the way the debate has dumbed down - the preoccupation with Julia Gillard’s appearance, Kristina Kenneally’s decision to let her hair grow out, Tony Abbott’s decision hardly to mention the budget in his budget reply speech - but I’m more interested in trying to explain why the dumbing down has come about. Suffice to say that evidence of the phenomenon can be found in the increased emphasis on ‘race-calling’ in political reporting (who’s winning, who’s losing; who’s up, who’s down), on personalities, trivialities, scandals and accusations, slogans and name-calling rather than reasoned debate.

Lindsay Tanner offered his explanation in his book Sideshow: Dumbing Down Democracy. He argues it’s pretty much all the fault of the media, which is under siege from commercial pressures and technological change. Since the politicians must use the media to communicate with the electorate, they’ve had little choice but to dumb down their message to meet the media’s demands. The Canberra press gallery’s response to this thesis was predictably defensive, passing a lot of the blame back to the pollies. So, which side is to blame? Well, here a bit if economic training comes in handy: to be convincing, any explanation of some development has to provide reasons from both the demand side and the supply side. In other words, I think we can share the blame roughly evenly between the media on the demand side and the pollies on the supply side.

Let’s start with the media. And let me start by observing that much of the media has always been pretty dumb. The tabloids have always been tabloid and the commercial electronic media - radio and television - have never been terribly earnest in their coverage of politics. I think it’s true, however, that the tabloids have become dumber over the years: more hyped up, more inclined to emotional outbursts than factual reporting. Even so, when people complain about the debate dumbing down, I suspect most of their complaints relate to what they read in the quality press - or on the quality press’s websites.

In my 37 years in journalism I’ve been particularly conscious of the way old professional standards - being a paper of record, strict separation of news and opinion, the avoidance of subjects considered sordid - have given way to more overt commercial considerations. Part of this I attribute to microeconomic reform, especially deregulation of the capital market, which has intensified competition in general and, in particular, the sharemarket’s scrutiny of the adequacy of the newspaper companies’ profit performance.

For many years newspapers have faced steadily intensifying competition from other media. For as long as I’ve been in this business newspapers have worried about their circulation figures, which have been falling heavily relative to population growth and, more recently, have been falling in absolute terms. This I take to be explained by the increased competition they face from the ever-growing list of other ways for people to spend their leisure time. Television long ago became the main way people get their news, and the rise of talk radio and radio talkback was pinching our customers long before the arrival of the internet, with its multitude of alterative news sources, including the newspapers’ own websites.

Evening television news bulletins and breakfast radio programs were stealing the thunder of morning newspapers long before the internet began delivering ‘breaking news’ to people in their offices throughout the day. Because the electronic media and the new media are so much better at breaking news, the media have been feeding the public’s natural impatience to know the very latest. But breaking news gives primacy to immediacy over meaning. It’s undigested news - often unable to give an adequate account of what happened, let alone how it happened and why. Breaking news is dumbed-down news.

A related phenomenon is the long-emerging 24-hour news cycle, which has been reinforced by the arrival of 24-hour news radio and television channels. This increased output of news greatly increases the demand for news items and for new news items as the day progresses. It has the effect of shortening attention spans and it may well be that increased quantity comes at the expense of quality reporting and commentary. Speaking of attention spans, television and radio news stories are getting briefer, with the grabs of ‘actuality’ from politicians getting ever shorter. Politicians are able to repeat slick slogans without having to elaborate or defend them.

The arrival of the internet poses a considerable threat to the survival of newspapers - particularly the quality press - as they lose the formerly highly lucrative classified advertising and some display advertising, but also lose readers -particularly younger readers who prefer to read our offerings on the net, on tablets or on smartphones.

With all these pressures, is it surprising newspapers are trying to attract more readers by making their news more entertaining and, in the process, dumbing it down? Journalists have long understood that people prefer stories - narrative - to analysis, and stories about people rather than concepts. News has always been a combination of the important and the interesting, so the news media have responded to increased competitive pressures by increasing the interest component at the expense of the importance component. They have personalised politics by focusing on individuals, particularly leaders, making it more presidential. They have increasingly covered politics as though it was a spectator sport rather than policy debate. They have made the news more exciting by focusing on conflict and controversy rather than reasoned debate. They have made the news more entertaining by focusing more on gaffes and gimmicks. They have always understood that their audience finds bad news more exciting than good news, but they have stepped up the search for bad news, allowing it to crowd out the reporting of straight news about the facts of policy proposals. They spend most of each parliamentary term demanding the opposition produce its policies, but then devote little attention to those policies when finally they are produced.

Newspaper websites are often much dumber than the papers themselves, with a lot of perfunctory news stories, sexy photos, gimmicky stories and stories about celebrities. This is partly because the internet audience is much younger and also because the online editors get real-time feedback on what people are clicking on, and what they click on is sexy photos and stories about celebrities. The better informed editors are about the customers’ ‘revealed preference’, the harder it is to feed them material they feel would be better for them.

I believe the advent of talkback radio has had a big influence on politics and political reporting. It is very much news as entertainment, particularly the engendering of indignation about the claimed failures of officialdom. Shock jocks have broken down earlier conventions about subjects considered off-limits, particularly those with xenophobic or racist overtones. This has affected the behaviour of other mediums - particularly the tabloids - and the politicians. The electronic media and the tabloids do much to cater to - and amplify - the public’s worries about crime. Once, the quality press avoided dwelling on the gruesome details of particular crimes, but in its efforts to attract and retain readers it now devotes a lot more space to crime reporting. Television thrives on colour and movement. If it bleeds, it leads. Television is well suited to covering natural disasters, and the print media have met this competition despite their disadvantage, leaving less room for politics and policy. The extended coverage of natural disasters is a form of voyeuristic entertainment. For completeness I should record that, over the years, the broadsheet papers have come to include a lot of overt entertainment, in the form of ‘lifestyle’ sections on television, food, fashion and weekend gig guides.

So the media have certainly played a major part in the dumbing down of the policy debate. But the politicians have also played a big part. Just as the media’s commercial imperative has become more dominant, so I believe the politicians have, in their own way, become more commercial. They’ve always sought to balance the conflicting goals of using power to make the world a better place and staying in office because it’s nice to be in charge. I think politicians on both sides now put a lot more emphasis on attaining and retaining office than on ensuring they use their time in office to achieve improvements. On the Labor side, but increasingly also on the Liberal side, politics is becoming a professional career structure, where you start out from university as a union or ministerial factotum, eventually working your way to the top of elected office. You become steeped in the backroom, cynical side of the game of politics - learning the tricks of attaining and retaining office - without gaining much experience of the outside world or, it seems, acquiring many deeply felt convictions about how the world needs to be changed.

Politics has also become more commercial - more professional, more scientific - with its increasing resort to the techniques of marketing and market research. In the old days politicians could only guess from personal contacts and experience how the policies they were pursuing would be received by the electorate of polling day. It was easier to convince yourself that something you really wanted to do would go down well. These days, opinion polls and focus groups leave both sides in little doubt about exactly what voters are thinking and feeling about particular policies. Note, however, that these things give the public’s opinions a constancy and stability they don’t possess. In earlier times, qualitative research was use to help politicians shape arguments to sell the policies they wished to introduce; these days, the lifetime professional-career approach to politics makes it a lot more tempting to use qualitative research to decide what your policies should be.

It also makes it tempting to confirm to the media’s whims if that’s what’s needed to connect with the electorate. Politicians now spend a lot more time inspecting disaster sites, getting in on the story, demonstrating their authority and their concern - and otherwise wasting time. Politicians and their bureaucrats devote a lot of time to coming up with minor ‘announceables’ to feed to the ever-demanding 24-hour news machine and fixing the problems of particular individuals whose case attracts the media’s attention.

Even so, it’s misguided to see politicians as innocent victims of the demanding media machine. To a great extent the media are open to being used as a tool by governments and interest groups. All governments and oppositions see ‘media management’ (read, manipulation) as a major part of the successful performance of their jobs. I don’t believe it was merely to oblige the media that politicians moved to a presidential style of politics; it suited the politicians’ marketing objectives just as it suited the media’s needs for personalisation. Similarly, it’s the politicians who choose to humanise themselves by being accompanied by their spouse and children on the campaign trail or being interviewed at home by a women’s magazine. Politicians and interest groups happily exploit the media’s disinclination to critically examine claims that are bad news before shouting them from the rooftops, such as that some proposed government measure will destroy 10,000 jobs. In moments of weakness some politicians have explained that keeping the media regularly fed with minor announceables keeps them too occupied to have time to go digging for their own, possibly less favourable stories.

Politicians have long understood that, in politics, the perception can be just as important as the reality. Their new-found access to knowledge of exactly how the public perceives policy questions can tempt them to concentrate on manipulating perceptions while neglecting to attend to the reality of government performance - which, if allowed to deteriorate too greatly, won’t fail to register on the public’s perceptions about a government’s competence.

I suspect the growing careerism in politics has caused the fight for office to become more intensely competitive, prompting politicians to seek short-term advantage at the expense of their profession’s long-term credibility with the electorate: to be more willing to make and break election promises, find deceptive ways of expressing things and take the fight into areas formerly held by tacit agreement to be off-limits, such as immigration and asylum seekers. The politicians themselves must accept most of the blame for this aspect of the dumbing down of the policy debate.

But let me finish by saying that, in some ways, the media discussion of politics and policies is richer than ever before. As part of its effort to compete with the greater immediacy of the electronics - and perhaps also in response to a much better educated and more economically literate audience - the quality press devotes a lot more space to commentary and analysis than it used to, and only a portion of this is the mere assertion of intemperate opinions. Much of it is analysis of policy issues by specialist journalists or academics. Then we have the media’s opinion websites, plus the universities’ The Conversation website, and any number of blogsites - both local and international - where academics and other erudite souls debate policy issues at a level of sophistication much higher than in any newspaper. The politicians themselves may not be conducting a very edifying policy debate, but if that’s what you want you can find it without too much effort.

NSW: Not all that different but clearly better

2011-09-07T09:23:00.002+10:00

This is the I-solemnly-promise-to-be-tough budget. Its nasties come as an IOU. When the whole state had its tongue hanging out for deliverance from the Carr-Iemma-Rees-Keneally government, some wondered just how different and better Barry O'Farrell would be.

Now we have our answer. Not all that different, but clearly better. We hope.

Incoming governments usually cut savagely in their first budget, knowing all the nastiness can be blamed on their hopeless predecessors. But O'Farrell is a man of moderate convictions and modest ambition.

He's done enough - on paper, at least - to steer the budget back to surplus in the financial year after this, but not nearly enough to produce the ever-growing surpluses necessary to permit the greatly increased spending on infrastructure he says we need.

Truth is, this budget is remarkably similar to the budgets we had from Labor: full of resolutions to be pure, but not yet. It promises annual growth in recurrent spending of less than 4 per cent in the three years of the forward estimates, but 7.1 per cent in the budget year.

It promises the most minuscule operating surpluses in the three "out years" but a collapse into deficit (to the tune of $718 million) in the budget year, after a surplus of $1264 million in Labor's last year.

To be fair, most of that deterioration isn't the fault of O'Farrell and his Treasurer, Mike Baird. Of the total worsening of almost $2 billion, about 45 per cent is explained by the withdrawal of federal government stimulus spending and the standard, but misleading, accounting treatment of it in the state budget.

Another 45 per cent is explained by the expected deterioration in state revenues after the very recent slowdown in the economy.

But that leaves a worsening of $226 million put in by O'Farrell's hand, the net cost of all his unfunded election promises.

Of the promised spending savings of $8 billion over four years, much had already been announced by the Labor government. That's particularly true of the $6 billion in savings from imposing "efficiency dividends" on government departments.

One genuinely new measure is $800 million in savings from cuts in particular spending programs. It's these that could impose pain on particular parts of the community.

But no measures were announced in the budget because none has yet been decided. Only when they are, and the public has reacted, will we know whether O'Farrell has the steel to bring the budget back to surplus.

One savings measure where O'Farrell has admitted copying Labor is his intention to limit state employees' pay rises to 2.5 per cent a year plus the proceeds from agreed cost savings.

The trouble with Labor's budgets was that they never delivered on promised future savings. The donkey never got to eat the carrot.

The only hope for O'Farrell and Baird is that they will deliver. O'Farrell's willingness to enshrine his wages policy in law is a hopeful sign. But at this stage hope is all we can do.

Politics of self-interest feeds the inner beast

2011-09-07T09:22:00.000+10:00

Barring the start of World War III, we may never hear an Australian politician repeat John Fitzgerald Kennedy's unforgettable line, "Ask not what your country can do for you - ask what you can do for your country".

Nobility be hanged. There was a time when our leaders saw it as their job to bring out the best in their followers. These days, they see their best chance as pandering to our dark side - our fears, our weaknesses, our selfishness.

These days, self-centredness not only comes naturally, it's officially encouraged. On what basis should you decide which politician to support? The one that's offering you the best deal, of course.

Why do our leaders have such a low opinion of our motivations? Perhaps for the same reason people who lie a lot always expect other people to be lying. Despite their protestations to the contrary, most politicians seem motivated less by a burning desire to make the world a better place than by ambition for personal advancement. They simply assume we are like they are.

Then there's the influence of economists. The doctrine of economic rationalism not only assumes self-interest to be normal and altruism to be non-existent, it sanctifies self-interest as a civic virtue.

Adam Smith, founder of modern economics, said a lot of noteworthy things, but few are quoted more than this: "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages."

Be as selfish as you like because selfishness is what makes the economy work.

But here's a balancing quote from the great man that's much less often repeated: "How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it."

There are two sides to our nature; we do have our "better angels" as Abraham Lincoln put it, but at present our lesser selves are in the ascendancy.

Perhaps another influence on the politicians is their resort to the techniques of marketing to further their pursuit of power. Marketers have no hesitation in appealing to our envy, lust or greed.

In their world, use of the word "indulgence" is taken to be enticing, not a condemnation. "You deserve it" and "because you're worth it", advertisers assure us. My favourite is an ad for a cinema candy bar: "in the dark, no one can see you". Go ahead, guts yourself.

Marketers use focus groups to test products and make sure they're giving the customers exactly what they want. Politicians use them to make sure they're telling voters exactly what they want to hear.

At least since John Howard's last days, people in focus groups have been complaining about the rising cost of living. Really? That's a new one. When the most people can do is complain about the cost of living it's a sign they've got nothing bigger to worry about. I suspect it's the product of our having gone 20 years without a severe recession. When you're worried about keeping your job, you don't complain about the cost of living.

And yet both sides of politics are perpetually echoing back to the electorate their professed concern about how tough times are. Tony Abbott's remarkably successful scare campaign against the carbon tax - it's actually not half as bad as the goods and services tax, and certainly far less disruptive than the effect of the high dollar on manufacturing and tourism - preys on people's worries about the cost of living.

When Howard was introducing the GST a lot of people's attitude was: "I don't like the sound of it one bit, but if you're insisting on it I suppose it must be in the best interests of the country." Much the same could be said of the carbon tax, yet far fewer people are saying it - nor are they being encouraged to think that way.

As it's understood by scientists, our preoccupation with our own interests usually extends to the protection of our own family. But there seems little sign of concern for the wellbeing of our children and grandchildren in the carbon tax debate. We've been encouraged to focus only on our immediate worries about balancing the household budget.

But for unbridled selfishness there could surely be no more egregious example than the success the licensed clubs have had in stirring their members' opposition to the Gillard government's reluctant championing of compulsory pre-commitment on poker machine use.

If ever there was an action that could be said to be "un-Australian", it's profiting from the addiction of gamblers and all the misery caused to them and their families. The killer statistic is this: according to the Productivity Commission, about 15 per cent of regular poker machine users contribute about 40 per cent of all the money put through pokies.

So the whole edifice of the licensed club industry rests heavily on the exploitation of a small minority of their own members. All the cheap meals and shows, all the grants to local sporting groups - much of that money is coming from the pockets of the spouses and children of problem gamblers.

But those fighting to keep their cheap meals mustn't feel guilty. You're only doing what our politicians, economists and advertisers urge you to do: putting your own interests ahead of other people's, including the less fortunate.

Productivity weak, but that's not all bad

2011-09-05T18:07:00.000+10:00

Before you get too panic-stricken about Australia's poor productivity record, consider this: maybe it's a good sign. If you've been given the impression productivity can be weak only for bad reasons, you've been misled. Productivity - output per unit of input - is only what you could call a key performance indicator; a means to an end, not an end in itself.

The end is the material well being of the Australian people. And there are plenty of things that improve our well-being (or ''welfare'' as economists call it) while worsening measured productivity.

This is an uncontroversial point among economists and has been acknowledged by the leading protagonists in the productivity debate, the secretary to the Treasury, Dr Martin Parkinson, and Saul Eslake of the Grattan Institute. But you have to read their fine print to find that acknowledgement.

The productivity of labour in the mining industry has declined by about 40 per cent since 2001-02, but that's mainly because much work is being done on the installation of additional production capacity, without that additional capacity yet coming on line and adding to output. When eventually it does, the industry's productivity will be much improved.

Another factor affecting mining is that the exceptionally high prices we're receiving for our minerals have prompted firms to mine lower-grade or harder-to-get-at ore. Is it a bad thing it's now economic to mine and sell second-grade minerals? Hardly - well, not from our standard materialist viewpoint.

Labour productivity has dropped by about a third in our utilities sector (electricity, gas and water). Electricity and gas businesses are investing heavily to expand their production capacity, replace ageing transmission infrastructure and meet renewable energy targets.

Similarly, governments have undertaken significant investment in water infrastructure - including desalination plants in five states - to guarantee security of supply during droughts.

Once again, none of these developments is bad, notwithstanding their adverse effect on measured productivity. The experts disagree on how much of the overall deterioration in productivity is accounted for by mining and utilities. Some say a lot of it.

But another factor contributing to our poor productivity performance is that, with an unemployment rate of 5 per cent or so for more than a year, we're close to full employment. This means firms are having to employ people who wouldn't be their first pick for the job, thereby lowering the average productivity of their workforce.

Is this a bad thing? On the contrary, it's wonderful the economy is in a position to provide work for these people. This, after all, is one of the main things we want from our economy: that it generate jobs for all those who want them.

It's possible something similar is happening to the productivity of our capital equipment. Some firms may be using whatever old or second-rate machines they can get their hands on so as to keep up with demand. Again, not such a bad thing.

I wrote some weeks ago that the big microeconomic reform push of the 1980s and '90s proved disappointing in its effect on productivity. It produced a once-off lift in the level of our productivity, but failed to achieve the lasting increase in our rate of productivity improvement.

But there was a different respect in which micro reform yielded a quite unexpected benefit: it made the economy a lot more flexible and resilient in response to economic shocks. By increasing the degree of competition in many markets, it reduced firms' pricing power (and hence their unions' bargaining power), thus making the economy significantly less inflation-prone.

In consequence, the macro economy became much easier to manage. Combine that with the authorities' adoption of more disciplined frameworks for the conduct of monetary and fiscal policies, and you probably have much of the explanation for our record of 20 years without a severe recession.

Is that a good thing? Of course it is. It's a remarkable achievement. But in economics everything has an opportunity cost and even good things have their drawbacks. It's highly likely the drawback of going for so long without a serious recession is an ever-weakening productivity performance.

As Dr Diane Coyle wrote in her book, The Economics of Enough, ''a recession is a period of faster industrial restructuring rather than simply an economy-wide reaction to a common shock''.

When times are good - and, despite our recent complaints, times have been very good for most of our businesses for many years - firms aren't under a lot of pressure to improve their performance. It often takes adversity to oblige firms to try harder and lift their game. Inefficiencies and unsuccessful projects can be overlooked when times are good. They tend to accumulate. But when times get tough there's a lot of spring cleaning.

So, as Coyle implies, structural change tends to occur in bunches at the time of recessions, rather than continuously as textbooks assume.

Of course, this process of ''creative destruction'' during recessions can be very painful, involving a lot of workers losing their jobs.

As a case in point, it's likely the adjustment being imposed on our manufacturers by the high dollar will leave productivity a lot higher in what's left of manufacturing. Many firms will really have to improve their performance if they're to survive.

So, not to worry. Sooner or later the economy will face another severe recession - the business cycle is far from dead - and once it has done its worst and we're into the recovery phase our productivity figures are likely to look much better.

Is this time different?

2011-09-03T08:25:00.000+10:00

When the Queen asked economists why so few of them had foreseen the global financial crisis, our professor Geoff Harcourt and some other academics petitioned her to say, among other things, that one reason was their profession's loss of interest in economic history.

That sad truth was demonstrated convincingly by two American professors, Carmen Reinhart and Kenneth Rogoff, in a book which has since become a modern classic, This Time Is Different: Eight Centuries of Financial Folly . It's just out in paperback, published by Princeton University Press.

In their landmark study of hundreds of financial crises in 66 countries over 800 years, Reinhart and Rogoff find oft-repeated patterns that ought to alert economists when trouble is on the way. One thing stops them waking up in time: their perpetual belief that ''this time is different''.

But, as we're witnessing at present, even when economists and financial market players have been hit over the head by reality, their ignorance of history stops them understanding what happens next. Wall Street and Europe fondly imagined the Great Recession was behind them, only to discover it's still rolling on.

Reinhart and Rogoff could have told them - did tell them - financial crises of this nature aren't so easily escaped. The Great Recession was so called to signify that another depression had been averted.

The authors say a more accurate name would be the Second Great Contraction. ''The aftermath of systemic banking crises involves a protracted and pronounced contraction in economic activity and puts significant strains on government resources,'' they say.

They show that, in the run-up to America's subprime crisis, standard indicators such as asset price inflation, rising leverage (debt relative to the value of assets), large sustained current account deficits on the balance of payments and a slowing trajectory of economic growth exhibited virtually all the signs of a country on the verge of a severe financial crisis.

So why did so few economists recognise the signs? Everyone thought this time was different.

''Our basic message is simple,'' the authors say, ''we have been here before. No matter how different the latest financial frenzy or crisis always appears, there are usually remarkable similarities with past experience from other countries and from history.

''Recognising these analogies and precedents is an essential step towards improving our global financial system, both to reduce the risk of future crisis and to better handle catastrophes when they happen.''

When looking for the root cause of the global financial crisis, a lot of people put it down to human greed. That's true enough, but it doesn't give us much to work on.

The authors' studies lead them to a different culprit: debt. Credit is crucial to all economies, ancient and modern. Progress would be a lot slower without it. So the point is not that credit is bad, but that it's dangerous stuff.

''Balancing the risks and opportunities of debt is always a challenge, a challenge policymakers, investors and ordinary citizens must never forget,'' the authors say.

But ''if there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by government, banks, corporations or consumers, often poses greater systemic risks than it seems during a boom.

''Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are.''

Such large-scale debt build-ups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short-term and needs to be constantly

refinanced.

Again and again, countries, banks, individuals and firms take on excessive debt in good times without enough awareness of the risks that will follow when the inevitable recession hits. Many players in the financial system often dig a debt hole far larger than they can reasonably expect to escape from, most obviously in the US in the late 2000s.

''Government and government-guaranteed debt ? is certainly the most problematic, for it can accumulate massively and for long periods without being put in check by markets ? Although private debt certainly plays a key role in many crises, government debt is far more often the unifying problem across the wide range of financial crises we examined.''

Financial crises are nothing new. They've been around since the development of money and financial markets. And they follow a rhythm of boom and bust through the ages. ''Countries, institutions and financial instruments may change across time, but human nature does not,'' they say.

Human nature brings us to the Achilles heel of debt: confidence. ''Perhaps more than anything else, failure to recognise the precariousness and fickleness of confidence - especially in cases in which large short-term debts need to be rolled over continuously - is the key factor that gives rise to the this-time-is-different syndrome.

''Highly indebted governments, banks or corporations can seem to be merrily rolling along for an extended period, when bang! - confidence collapses, lenders disappear and a crisis hits.''

We've come to believe sovereign debt defaults are unthinkable and extremely rare. This may be partly because ''a large fraction of the academic and policy literature on debt and default draws conclusions based on data collected since 1980''.

The book focuses on two particular forms of financial crises: sovereign debt crises and banking crises. The present global crisis began with failing banks and has now proceeded to the threat of sovereign debt default.

Which, having looked at more than a mere 30 years of data, we now discover is quite common. Had economists been researching the question with the diligence of Reinhart and Rogoff - who put most of their effort into assembling a massive database covering 66 countries for up to 800 years - they may have come up with a little statistic it would have been handy to know a bit earlier.

On average, government debt rises by 86 per cent during the three years following a banking crisis. And that's not the cost of the bank bailouts. It's mainly because banking crises ''almost invariably lead to sharp declines in tax revenues as well as significant increases in government spending''.

Had we known our history, it wouldn't have surprised us that, when you start with heavily indebted governments, a banking crisis soon leads to a sovereign debt crisis.

Invest in children of knowledge revolution

2011-08-31T07:31:00.000+10:00

It's annoying the way business people keep slipping the words ''going forward'' into almost every sentence and it was even worse when Julia Gillard kept repeating the slogan ''moving forward'' in the last election campaign. But I have to admit they've got the right idea: we do need to keep our minds focused on the future and what we need to do to secure it.

The world keeps changing and we must respond appropriately to that change. Most of us feel threatened by change, and it's only human to want to resist it. The temptation is to try to preserve things as they are, rather than adjust to the way they will be.

As we wonder what to do about the threat to our manufacturing industry, it's tempting to see that threat as temporary. We're in the middle of a resources boom which has lifted the value of our dollar to a level which could wipe out some of our industry. But the boom won't last long and, if we're not careful, we could find ourselves high and dry: no boom and a big chunk cut out of manufacturing. What do we do then?

This is a serious misreading of our situation. What we're dealing with isn't just another of the transitory commodity booms we've experienced many times before. It's a historic shift in the structure of the global economy as the Industrial Revolution finally reaches the developing countries. The two biggest countries in the world, China and India, which were also the biggest economies before that revolution, are rapidly industrialising and within the next 20 or 30 years will return to their earlier position of dominance.

Does that sound temporary to you?

As part of their urbanisation and industrialisation, those countries - and the Vietnams and Indonesias following in their wake - will require huge quantities of iron ore, coal and other raw materials. Not for several months but for several decades. Much of what they need will be coming from us. That says it's likely to be many moons before our dollar falls back to the US70? levels our high-cost manufacturers are comfortable with.

The other side of the re-emergence of China and India is the global shift of all but the most sophisticated manufacturing from west to east. This is a disruptive trend affecting all the developed economies, not just us. All the rich countries are having to find other things to do as their manufacturing migrates to the poor countries.

This, too, is not a process that's likely to stop, much less reverse itself. So it's not a question of hanging in until the world comes back to its senses and things return to normal. The day will never come when we're able to reopen our steel mills and canning factories.

It's a question of whether we dig in and try to prevent our economy changing, or we adapt to our changed circumstances and move into areas more suited to a rich, well-educated, highly paid economy.

In truth, we're making so much money from our sales of raw materials to the developing countries that we could afford to use a fair bit of that income to prop up our manufacturers. That wouldn't make us poorer, just less prosperous than we could be (though keeping labour and capital tied up in manufacturing would mean a lot more immigration and foreign investment to meet the needs of our rapidly expanding mining sector).

And the fact is that, throughout most of the 20th century, we diverted a fair bit of our income from agriculture and mining to subsidising our then highly protected manufacturing sector. This may help explain why so many people - particularly older people - are so ready to do whatever it takes to stop factories being closed. It's the traditional Australian way of doing things: passing the hat.

But what's the positive, future-affirming alternative? What else can we do?

Embrace the newer revolution in the developed world, the Information Revolution. While the poor countries are becoming manufacturing economies, the rich countries are becoming knowledge economies.

The knowledge economy is about highly educated and skilled workers selling the fruits of their knowledge to other Australians and people overseas. It covers all the professions and para-professions: medicine, teaching, research, law, accounting, engineering, architecture, design, computing, consulting and management.

Jobs in the knowledge economy are clean, safe, value-adding, highly paid and intellectually satisfying.

The developed economies are fast becoming ''weightless'', as an ever smaller proportion of income and employment comes from making things and an ever increasing proportion comes from providing services. Some of those services are fairly menial, but the fastest growing categories involve the highest degrees of knowledge and skill.

Employment in Australian manufacturing has been falling since the 1980s. It's sure to continue falling whatever we do to try to prop it up. By contrast, since 1984 total employment has grown by almost three-quarters to 11.4 million. Get this: all of those 4.8 million additional jobs have been in the ''weightless'' services sector.

Notwithstanding our future increase in the production of rural and mineral commodities, our economy - like all the rich economies - will continue to lose weight. The real question is whether the services sector jobs our children and grandchildren get will be at the unskilled or the sophisticated end of the spectrum.

And that depends on how much money and effort we put into their education and training. We've gone for the past two decades underspending on education and training at all levels, falling behind the other rich countries.

If we've got any sense, we'll use part of the proceeds from the resources boom to secure our future in the global knowledge economy.