What they don't tell you about how the budget works

Now we have some space, there are things I should tell you that there’s never time for on budget night. If you don’t know these things, the media can unwittingly mislead you, and the government spin doctors can knowingly mislead you.

A budget’s just a plan for how much income you’re expecting in the coming period, and what you want to spend it on. Governments have budgets and so do businesses and families.

You may think you know a lot about budgeting and that all you need is common sense, but the federal government’s budget ain’t like any other budget you’ve known.

Where people go wrong is assuming the government’s budget is the same as their own household budget, only much bigger. Families budget so they don’t end up spending more than they earn.

But governments often spend more than they raise in taxes – run at a “deficit” – and only occasionally spend less than they raise – run a “surplus”. When they run deficits, they borrow to cover it; when occasionally they run a surplus, they can pay back a bit of it.

Governments can borrow, and keep borrowing, in a way families can’t. Why? Because they can’t go broke. When they run short of money, they can do what no family can do: order all the other families to give them money. It’s called taxation.

And national governments can go one step further and print their own money. Money is just a piece of plasticky stuff that’s worth, say, $50. Why is it worth $50? For no reason other than that the government says it is, and everyone believes it.

Actually, these days the government doesn’t print money so much as create it out of thin air, by crediting bank accounts. This is done not by the government itself, but by a bank the government owns: the Reserve Bank. It created hundreds of billions during the pandemic (although now the Reserve is making the government gradually pay it back, by actually borrowing the money).

Everyone knows that whatever you borrow has to be paid back. What’s more, you have to keep paying interest on the debt until it is paid back. Parents know they have to get any home loan paid back before they retire.

The trouble with a family is that eventually it dies. The kids grow up and start families of their own, then mum and dad pop off. But governments don’t die. The nation’s government acts on behalf of all the families in the country. There are always some families dying, but always others taking their place.

This is why families have to pay back their debts, but governments don’t – and often choose not to. Because governments go on and on, the main way they get on top of their debts is by waiting for the economy to outgrow them, so the size of their debt declines relative to the size of the economy.

Remember, unless you add to it, a debt is a fixed dollar amount, whereas the size of the economy – gross domestic product – grows with inflation and “real” economic growth.

The final thing making government budgets different from family budgets is that a particular family’s budget is too small to have any noticeable effect on the economy, whereas the federal budget is so big – about a quarter the size of the economy – that changes the government makes in its spending and taxing plans can have a big effect on an individual family’s budget and indeed, many families’ budgets.

But it also works the other way: what happens to one family won’t have a noticeable effect on the budget, but what happens to many families – say, everyone’s getting bigger pay rises, or many families are cutting back because they’re having trouble coping with the cost of living – certainly will affect the budget.

What common sense doesn’t tell you is that there’s a two-way relationship between the budget and the economy. The budget can affect the economy, but the economy can affect the budget.

Whenever a treasurer announces on budget night that he (one day we’ll get a she) is expecting the budget deficit to turn into a surplus, the media usually assume this must be because of something he’s done.

Possibly, but it’s more likely to be because of something the economy did. In this month’s budget, it’s because the economy’s been growing strongly, leading families and companies to earn more income and pay more tax on it.

Because many in the media imagine the government’s budget is the same as a family’s budget, they assume that budget deficits are always a bad thing and surpluses a good thing.

Not necessarily. If the budget was in surplus during a recession, that would be a bad thing because it would mean that, by raising more in taxes than it was spending, the budget would be making life even harder for families.

Only when the economy’s growing too fast and adding to inflation pressure is it good to have the budget in surplus and so helping to slow things down. And deficits are a good thing when the economy’s in recession because this means that, by spending more than it’s raising in taxes, the budget’s helping to prop up the economy.

But not to worry. When the economy goes into recession, the budget tends to go into deficit – or an existing deficit gets bigger – automatically. Why? Because people pay less tax and the government has to pay unemployment benefits to more people. Economists call this the budget’s “automatic stabilisers”.

Hidden away in the budget papers you find Treasurer Jim Chalmers quietly admitting he has no intention of trying to pay off the big public debt he inherited. His “overarching goal” is to “reduce gross debt as a share of the economy over time”.

Finally, for a family, a $4 billion surplus is an unimaginably huge sum of money. But for a federal government, it’s petty cash.

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How party politicking let mining companies wreck our economy

A speech by former Treasury secretary Dr Ken Henry last month was reported as a great call for comprehensive tax reform. But it was also something much more disturbing: an entirely different perspective on why our economy has been weak for most of this century and – once the present pandemic-related surge has passed – is likely to stay weak.

The nation’s economists have been arguing for years about why the economy has grown so slowly, why real wages have been stagnant for at least a decade, why the rate of productivity improvement is so low and why business investment spending has been so little for so long.

Most economists think we’ve just been caught up in the “secular stagnation” – or slow-growth trap – that all the advanced economies are enduring.

But Henry has a very different answer, one that’s peculiar to Australia. Unlike everyone else, he’s viewing our economy from a different perspective, the viewpoint of our “external sector” – our economic dealings with the rest of the world.

What conclusion does he come to? We’ve allowed ourselves to catch a bad case of what economists call “Dutch disease” – but Henry thinks should be renamed Old and New Holland disease.

When a country discovers huge reserves of oil or gas off its coast – or, in our case, the industrialisation of China causes the prices of coal and iron ore to skyrocket – all the locals think they’ve won the lottery and all the other countries are envious. Now we’ll be on easy street.

But when the Dutch had such an experience in the 1960s, they eventually discovered that, while it was great for their mining industry, it was hell for all their other trade-exposed industries.

Why? Because the inflow of foreign financial capital to build the new industry and the outflow of hugely valuable commodity exports send the exchange rate sky-high, which wrecks the international price competitiveness of all your other export and import-competing industries: manufacturing, farming and services.

Not only that. The rapidly expanding mining industry attracts labour and capital away from the other industries, bidding up their costs. Their sales are down, but their costs are up. You’re left with a “two-speed economy”. Remember that phrase? It’s what we’ve had for a decade or two.

Well, interesting theory, but where’s Henry’s evidence that Dutch disease is at the heart of our problems over recent decades?

He’s got heaps. Start with the way the composition of our exports has changed. Between 2005 and today, and in round figures, mining’s share of our total exports has doubled from 30 per cent to 60 per cent. Manufacturing’s share has fallen from 40 per cent to 20 per cent. Everything else – mainly agriculture and services – has fallen from 30 per cent to 20 per cent.

Over the same period, exports grew from 20 per cent of gross domestic product to 27 per cent. This means mining exports’ share of GDP has gone from about 6 per cent to more than 16 per cent. Manufacturing exports’ share has fallen from about 8 per cent to 5.5 per cent.

Next, who buys our exports? China’s share has gone from about 10 per cent to more than 45 per cent. Actually, that was the peak it reached before China’s imposition of restrictions after some smart pollie decided it would be a great idea for Australia to lead the charge of countries blaming China for COVID. Since then, China’s share has fallen to 30 per cent.

Since 2005, mining’s share of total company profits has gone from about 20 per cent to 50 per cent. Manufacturing’s share has fallen from about 20 per cent to less than 10 per cent. Financial services – banking and insurance – have seen their share fall from 20 per cent to less than 5 per cent.

Now, what’s happened to those industries’ share of total employment? Manufacturing’s share has fallen from more than 9 per cent to about 6 per cent. Financial services’ share has been steady at a bit over 3 per cent. Mining’s share has risen from less than 1 per cent to 1.5 per cent. You beauty.

“In summary,” Henry says, “mining employs a very small proportion of the Australian workforce – except in the boom times, when it induces a worker to leave other jobs for mine-site construction work – generates about 60 per cent of Australia’s exports, about half of pre-tax profits (mostly repatriated overseas to foreign shareholders) and exposes the Australian economy to highly volatile global commodity prices and a heavy strategic dependence upon a single buyer, China.”

Not to mention the way mining leaves us heavily exposed to “the risk of global decarbonisation”.

How have we profited from being a mining-dominated economy? Real GDP per person – a rough measure of our material standard of living – has been in trend decline for two decades. In the decade pre-pandemic, “we recorded the sort of growth rates only previously recorded in recessions,” Henry says.

This weakness is largely explained by our poor productivity performance. Though no one else seems to have noticed, our productivity growth is negatively correlated with our “terms of trade” – the prices we get for our exports, relative to the prices we pay for our imports.

That is, when our terms of trade improve, our rate of productivity improvement worsens. And our terms of trade are largely driven by world commodity prices, especially for coal, gas and iron ore.

Now the tricky bit. Why would a mining boom depress productivity improvement? Because of the way it raises our real exchange rate – our nominal exchange rate, adjusted for the change in our rate of production-cost inflation relative to those of our trading partners.

The resources boom increased our nominal exchange rate by about 25 per cent. Then, by 2011, high wages growth and weak productivity growth relative to our trading partners had added a further 35 per cent to the rise in the real exchange rate, Henry calculates.

This caused our non-mining producers to suffer a “profound loss of international competitiveness”. Is it any wonder that, between the turn of the century and 2019, the annual rate of investment by non-mining businesses fell from 7 per cent of GDP to 5 per cent?

The result is that two centuries of “capital-deepening” – increased equipment per worker – have stalled. This move to “capital-shallowing” explains our poor productivity.

And also, our move from current account deficit to current account surplus. “We are exporting [financial] capital because Australia has become an increasingly unattractive destination for doing business in the eyes of foreign investors and Australian [superannuation] savers alike,” Henry says.

“The mining boom has left us with a very big competitiveness overhang that will probably take decades to work off,” he says, including by decades of weak growth in real wages.

What should we have done differently? Had we applied a rational tax to the windfall profits of the mining companies, we would not only have retained for ourselves more of the proceeds from the export of our own natural resources, but also caused the rise in our real exchange rate to be lower.

Remember Kevin Rudd’s proposed “resource super profits tax”? The mining lobby set out to stop it happening, telling a pack of lies about how it would wreck the economy. The Abbott-led opposition threw its weight behind the mainly foreign miners.

Julia Gillard consulted the industry and cut the tax back to nothing much. The incoming Abbott government abolished it.

Petty, short-sighted politicking caused us to sabotage our economy for decades to come.

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Our days of productivity improvement may be gone for good

The Productivity Commission’s five-yearly report on our productivity performance seems to have sunk like a stone but, before it disappears without trace, it has one important thing to tell us: the obvious reason productivity improvement has slowed, and why, ceteris paribus, it will probably stay slow.

Economists like trying to impress people with Latin phrases. Many conclusions in economics depend on the assumption of ceteris paribus – all other things remaining unchanged. Economists are always holding all other variables constant while they see what effect a change in variable A has on variable B.

Trouble is, in the real world, all else almost never stays unchanged. In which case, the relationship between A and B that you thought you could rely on has been stuffed up by some other variable or variables between C and Z.

Back to the point. Everyone thinks they know what productivity means, but they often don’t. The commission’s report says productivity improvement is “the process by which people get more from less: more and better products to meet human needs, produced with fewer hours of work and fewer resources”.

“In many cases this growth occurs with lighter environmental impact” – a truth many scientists just can’t seem to get their heads around.

The report says that over the past 20 years, the rate of improvement in productivity has slowed in all the rich countries, but with Australia slowing more than most.

Why? Many reasons, no doubt, but one big one that ought to have been obvious, since the American economist William Baumol noticed it in the 1960s.

The fact is that most improvements in the productivity of labour come from advances in technology. You give workers better, “labour-saving” machines to work with, which allow them to produce more in a typical hour of work.

(The other big one is giving workers more education and training, which allows them to work more complicated machines – including computers and software – design more complicated machines and programs, and service complex machines.)

Trouble is, it’s easier to improve productivity in some industries than others. In particular, industries that produce goods – on farms, in mines and in factories – can, and have, hugely increase their productivity by mechanising and computerising. Same in utilities, transport and communications.

In the production of services, however, it’s much harder. Although some services can be delivered digitally – streaming video, say – with little involvement by workers, most services are delivered by people, from less-skilled services delivered by waiters, cleaners, bedmakers and shop assistants, to highly skilled teachers, nurses, doctors, lawyers and prime ministers.

You can give these workers a car or a mobile or a screen, or give a hairdresser a better pair of clippers, but there’s not a lot you can do to speed them up. As Baumol famously remarked, it takes an orchestra just as long to play a symphony today as it did in 1960 – or 1860.

After two centuries of playing this game, we’ve ended up with goods industries that are highly “capital-intensive” – lots of expensive equipment; not many workers – and service industries that are highly “labour-intensive”: many workers; not much equipment.

Which means the productivity of labour is sky-high in the goods sector, but not great in the services sector.

But here’s the trick. You might expect that wages will be much higher in the high-productivity goods sector and much lower in the low-productivity services sector. But no. Wage rates do vary according to the degree of skill a worker possesses, and on the demand for that particular skill.

But a cleaner in a factory gets paid pretty much the same as a cleaner in a lawyers’ office. And a doctor gets much the same working in a big factory’s clinic as in a hospital.

Why’s that? Because, if an economy is working properly (which ours isn’t at present), it’s the economy-wide improvement in productivity that tends to increase all real wages by about the same percentage.

This is brought about by market forces. Despite their low productivity, employers in the services sector have to pay higher wages to stop their workers moving to higher-paying jobs in the goods sector.

Remember too, that over time, mass production lowers the prices of manufactured goods. That’s particularly true if you judge it by how many hours of labour it costs to buy, say, a car or a restaurant meal.

What we’re saying is that, in rich, high-productivity economies such as ours, labour is the more expensive resource, and capital the less expensive resource.

It’s also true that there’s a limit to how much you can eat, how many cars you can drive and how many TV sets you can watch, but no yet-discovered limit to how many services you can pay other people to perform for you.

Put all that together and the goods sector’s share of the economy keeps getting smaller, while the services sector’s grows – to 80 per cent of the economy (gross domestic product) and 90 per cent of total employment.

But it also means that the sector which has little ability to improve the productivity of its labour also has to keep paying more for its labour as the goods sector increases the productivity of its labour.

Gosh, that’s not nice. No, which is why Baumol said that the services sector suffers from “cost disease”. And the services sector’s huge and growing share of the economy explains why productivity in the economy overall is improving more slowly than it used to.

But it could become even worse. If, as it seems, the goods sector has finally exploited almost all its potential to become more productive, and there’s not a lot of obvious scope to improve the services sector’s productiveness, it’s hard to see how we’ll get much more productivity-driven growth in the economy.

What a dismal prospect. Talk about the problems of affluence. You know, I don’t think the world’s poor have any idea how hard life will become for us.

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Much prosperity comes from government and the taxes it imposes

The Productivity Commission’s job is to make us care about the main driver of economic growth: productivity improvement. Its latest advertising campaign certainly makes it sound terrific. But ads can be misleading. And productivity isn’t improving as quickly as it used to. We’re told this is a very bad thing, but I’m not so sure.

The commission’s latest report on our productivity performance, “Advancing Prosperity”, offers a neat explanation of what productivity is: the rise in real gross domestic product per hour worked. So it’s a measure of the efficiency with which our businesses and government agencies transform labour, physical capital and raw materials into the goods and services we consume.

The economy – GDP – can grow because the population grows, with all the extra people increasing the consumption of goods and services, and most of them working to increase the production of goods and services.

It also grows when we invest in more housing, business machinery and construction, and public infrastructure. But, over time, most growth comes from productivity improvement: the increased efficiency with which we deploy our workers – increasing their education and training, giving them better machines to work with, and organising factories and offices more efficiently.

Here’s the ad for productivity improvement. “There has been a vast improvement in average human wellbeing over the last 200 years: measured in longer lives, diseases cured, improved mobility [transport and travel], safer jobs, instant communication and countless improvements to comfort, leisure and convenience.”

That’s all true. And it’s been a wonderful thing, leaving us hugely better off. But here’s another thing: neither GDP nor GDP per hour worked directly measures any of those wonderful outcomes. What GDP measures is how much we spent on – and how much income people earned from – doctors, hospitals and medicines, good water and sewerage, cars, trucks and planes, occupational health and safety, telecommunications, computers, the internet, and all the rest.

The ad man’s 200 years is a reference to all the growth in economic activity we’ve had since the Industrial Revolution. We’re asked to believe that all the economic growth and improved productivity over that time caused all those benefits to happen.

Well, yes, I suppose so. But right now, the commission’s asking us to accept that our present and future rate of growth in GDP and GDP per hour worked will pretty directly affect how much more of those desirable outcomes we get.

That’s quite a logical leap. Maybe it will, maybe it won’t. Maybe the growth and greater efficiency will lead to more medical breakthroughs, longer lives, cheaper travel etc, or maybe it will lead to more addiction to drugs and gambling, more fast food and obesity, more kids playing computer games instead of reading books, more time wasted in commuting on overcrowded highways, more stress and anxiety, and more money spent on armaments and fighting wars.

Or, here’s a thought: maybe further economic growth will lead to more destruction of the natural environment, more species extinction and more global warming.

Get it? It doesn’t follow automatically that more growth and efficiency lead to more good things rather than more bad things. It’s not so much growth and efficiency that make our lives better, it’s how we get the growth, the costs that come with the growth, and what we use the growth to buy.

Trouble is, apart from extolling growth and efficiency, the Productivity Commission has little to say about how we ensure that growth leaves us better off, not worse off.

Economics is about means, not ends. How to be more efficient in getting what we want. The neoclassical ideology – where ideology means your beliefs about how the world works and how it should work – says that what we want is no business of economists, or of governments. What we want should be left to the personal preferences of consumers.

The Productivity Commission has long championed neoclassical ideology. It wants to minimise the role of government and maximise the role of the private sector.

It would like to reduce the extent to which governments intervene in markets and regulate what businesses can and can’t do. It has led the way in urging governments to outsource the provision of “human services” such as childcare, aged care and disability care to private, for-profit providers.

It wants to keep government small and taxes low to maximise the amount of their income that households are free to spend as they see fit, not as the government sees fit.

Fine. But get this: in that list of all the wonderful things that economic growth has brought us, governments played a huge part in either bringing them about or encouraging private firms to.

We live longer, healthier lives because governments spent a fortune on ensuring cities were adequately sewered and had clean water, then paid for hospitals, subsidised doctors and medicines, paid for university medical research and encouraged private development of pharmaceuticals by granting patents and other intellectual property rights to drug companies.

Governments regulated to reduce road deaths. They improved our mobility by building roads, public transport, ports and airports. Very little of that would have been done if just left to private businesses.

Jobs are safer because governments imposed occupational health and safety standards on protesting businesses. The internet, with all its benefits, was first developed by the US military for its own needs.

The commission says that when we improve our productivity, we can choose whether to take the proceeds as higher income or shorter working hours.

In theory, yes. In practice, all the reductions in the working week we’ve seen over the past century have happened because governments imposed them on highly reluctant employers. Ditto annual leave and long-service leave.

I don’t share the commission’s worry that productivity improvement may stay slow. It won’t matter if we do more to produce good things and fewer bad things. But that, of course, would require more government intervention in the economy, not less.

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Most of us don't really want to be rich, for better or worse

When it comes to economics, the central question to ask yourself is this: do you sincerely want to be rich? Those with long memories – or Google – know this was the come-on used by the notorious American promoter of pyramid schemes, Bernie Cornfeld. But that doesn’t stop it being the right question.

It’s actually a trick question. Most of us would like to be rich if the riches were delivered to us on a plate. If we won the lottery, or were left a fortune by a rich ancestor we didn’t know we had.

But that’s not the question. It’s do you sincerely want to be rich. It ain’t easy to become rich by your own efforts, so are you prepared to pay the price it would take? Work night and day, ignore your family and friends, spend very little of what you earn, so it can be re-invested? Come unstuck a few times until you make it big? Put it that way and most of us don’t sincerely want to be rich. We’re not that self-disciplined and/or greedy.

The question arises because the Productivity Commission’s five-yearly report on our productivity performance has found that, as a nation, we haven’t got much richer over the past decade – where rich means our production and consumption of goods and services.

When business people, politicians and economists bang on about increasing the economy’s growth, they’re mainly talking about improving the productivity – productiveness – of our paid labour.

The economy – alias gross domestic product – grows because we’ve produced more goods and services than last year. Scientists think this happens because we’ve ripped more resources out of the ground and damaged the environment in the process.

There is some of that (and it has to stop), but what scientists can never get is that the main reason our production grows over the years is that we find ways to get more production from the average hour of work.

We do this by increasing the education and training of our workers, giving them better machines to work with, and improving the way our businesses organise their work.

But the commission finds that our rate of productivity improvement over the past decade has been the slowest in 60 years. It projects that, if it stays this far below our 60-year average, our future incomes will be 40 per cent below what they could have been, and the working week will be 5 per cent longer.

It provides 1000 pages of suggestions on how state and federal governments can make often-controversial changes that would lift our game and make our incomes grow more strongly.

So, this is the nation’s do-you-sincerely-want-to-be-rich moment. And my guess is our collective answer will be yeah, nah. Why? For good reasons and bad. Let’s start with the negative.

If you think of the nation’s income as a pie, there are two ways for an individual to get more to eat. One is to battle everyone else for a bigger slice. The other is to co-operate with everyone to effect changes that would make the pie – and each slice - bigger.

For the past 40 years of “neoliberalism”, which has focused on the individual and sanctified selfishness, we’ve preferred to battle rather than co-operate.

Our top executives have increased their own remuneration by keeping the lid on their fellow employees’ wages. Governments have set a bad example by imposing unreasonably low wage caps.

Then they wonder why their union won’t co-operate with their efforts to improve how the outfit’s run. Workers fear there’ll be nothing in it for them.

It’s the same with politics. Governments won’t make controversial changes because they know the opposition will take advantage and run a scare campaign.

But there are also good reasons why we’re unlikely to jump to action in response to the commission’s warning. The first is that economists focus on the material dimension of our lives: our ability to consume ever more goods and services.

We’re already rich – why do we need to be even richer? There’s more to life than money, and if we gave getting richer top priority, there’s a big risk those other dimensions would suffer.

Would a faster growing economy tempt us to spend less time enjoying our personal relationships? How would that leave us better off overall (to coin a phrase)?

How much do we know about whether the pace of economic life is adding to stress, anxiety and even worse mental troubles?

If we did go along with the changes the commission proposes, what guarantee is there that most of the increased income wouldn’t go to the bosses (and those terrible people with more than $3 million in superannuation)?

What we do know is that we should be giving top priority to reducing the damage economic activity is doing to the natural environment, including changing the climate. If that costs us a bit in income or productivity, it’s a price worth paying.

And there are various ways we could improve our lives even if our income stopped growing. Inquire into them.

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Now the hard part for the RBA: when to stop braking

In economics, almost everything that happens has both an upside and a downside. The bad news this week is that the economy’s growth is slowing rapidly. The good news – particularly for people with mortgages and people hoping to keep their job for the next year or two – is that the slowdown is happening by design, as the Reserve Bank struggles to slow inflation, and this sign that its efforts are working may lead it to go easier on its intended further rises in interest rates.

But though it’s now clear the economy has begun a sharp slowdown, what’s not yet clear is whether the slowdown will keep going until it turns into a recession, with sharply rising unemployment.

As the Commonwealth Bank’s Gareth Aird has said, since the Reserve Bank board’s meeting early last month, when it suddenly signalled more rate rises to come, all the numbers we’ve seen – on economic growth, wages, employment, unemployment and the consumer price index – have all come in weaker than the money market was expecting.

What’s more, he says, only part of the Reserve’s 3.25 percentage-point rate increase so far had hit the cash flow of households with mortgages by the end of last year.

“There is a key risk now that the Reserve Bank will continue to tighten policy into an economy that is already showing sufficient signs of softening,” Aird said.

That’s no certainty, just a big risk of overdoing it. So while everyone’s making the Reserve’s governor, Dr Philip Lowe, Public Enemy No. 1, let me say that the strongest emotion I have about him is: I’m glad it’s you having to make the call, not me.

Don’t let all the jargon, statistics and mathematical models fool you. At times like this, managing the economy involves highly subjective judgments – having a good “feel” for what’s actually happening in the economy and about to happen. And it always helps to be lucky.

This week, the Australian Bureau of Statistics’ “national accounts” for the three months to the end of December showed real gross domestic product – the economy’s production of goods and services – growing by 0.5 per cent during the quarter, and by 2.7 per cent over the calendar year.

If you think 2.7 per cent doesn’t sound too bad, you’re right. But look at the run of quarterly growth: 0.9 per cent in the June quarter of last year, then 0.7 per cent, and now 0.5 per cent. See any pattern?

Let’s take a closer look at what produced that 0.5 per cent. For a start, the public sector’s spending on consumption (mainly the wage costs of public sector workers) and capital works made a negative contribution to real GDP growth during the quarter, thanks to a fall in spending on new infrastructure.

Home building activity fell by 0.9 per cent because a fall in renovations more than countered a rise in new home building.

Business investment spending fell by 1.4 per cent, pulled down by reduced non-residential construction and engineering construction. A slower rate of growth in business inventories subtracted 0.5 percentage points from overall growth in GDP.

So, what was left to make a positive contribution to growth in the quarter? Well, the volume (quantity) of our exports contributed 0.2 percentage points. Mining was up and so were our “exports” of services to visiting tourists and overseas students.

But get this: a 4.3 per cent fall in the volume of our imports of goods and services made a positive contribution to overall growth of 0.9 percentage points.

Huh? That’s because our imports make a negative contribution to GDP, since we didn’t make them. (And, in case you’ve forgotten, two negatives make a positive – a negative contribution was reduced.)

So, the amazing news is that the main thing causing the economy to grow in the December quarter was a big fall in imports – which is just what you’d expect to see in an economy in which spending was slowing.

I’ve left the most important to last: what happened to consumer spending by the nation’s 10 million-odd households? It’s the most important because it accounts for about half of total spending, because it’s consumer spending that the Reserve Bank most wants to slow – and also because the economy exists to serve the needs of people, almost all of whom live in households.

So, what happened? Consumer spending grew by a super-weak 0.3 per cent, despite growing by 1 per cent in the previous quarter. But what happened to households and their income that prompted them to slow their spending to a trickle?

Household disposable income – which is income from wages and all other sources, less interest paid and income tax paid by households – fell 0.7 per cent, despite a solid 2.1 per cent increase in wage income – which reflected pay rises, higher employment, higher hours worked, bonuses and retention payments.

But that was more than countered by higher income tax payments (as wages rose, with some workers pushed into higher tax brackets) and, of course, higher interest payments.

All that’s before you allow for inflation. Real household disposable income fell by 2.4 per cent in the quarter – the fifth consecutive quarterly decline.

That’s mainly because consumer prices have been rising a lot faster than wages. So, falling real wages are a big reason real household disposable income has been falling, not just rising interest rates.

Real disposable income has now fallen by 5.4 per cent since its peak in September quarter, 2021.

But hang on. If real income fell in the latest quarter, how were households able to increase their consumption spending, even by as little as 0.3 per cent? They cut the proportion of household income they saved rather than spent from 7.1 per cent to an unusually low 4.5 per cent.

If I were running the Reserve, I wouldn’t be too worried about strong consumer spending stopping inflation from coming down.

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Caring folk care about early learning. So do hard-nosed economists

So, what did you make of the Albanese government’s Early Years National Summit at Parliament House on Friday? What? You didn’t hear about it? Well, yes, it got little coverage from the media. Yet another case of us letting the urgent and the controversial crowd out the merely very important and the encouraging. Maybe it’s a pity Peter Dutton hasn’t said he was thinking of opposing it.

In truth, the government’s election promise – to do a better job of delivering what’s now called ECEC, early childhood education and care – is its most expensive and, after climate change, probably its most important. The two have much in common, of course: the wellbeing of our kids and grandkids.

Note the way our need for affordable and available childcare has morphed into a concern to start children’s education much earlier than age 5.

Neuroscience long ago established that our brains develop continuously from birth to adulthood, but the development in the first five years of life is crucial to later development. It’s determined partly by our genes, but also by our experiences in the early years. Children who are badly treated, or don’t get enough attention, are likely to have problems in later life.

To put it more positively, there’s now much evidence that good quality early childhood programs help children get a better education. Starting earlier seems to help kids “learn how to learn”. All children benefit, but those from disadvantaged homes benefit most.

Other research shows that early learning leads to better health, reduced engagement in risky behaviours such as smoking, drinking, drug taking and over-eating, and stronger civic and social engagement.

These benefits to individuals are, in themselves, sufficient justification for government spending on early learning. But the benefits spill over to their families and the wider community.

As well, the economy benefits from having more people working rather than in and out of unemployment. This improves government budgets by increasing the number of taxpayers, as well as by reducing the need for remedial spending on school drop-outs or people with literacy problems. Or those who’ve got into trouble with the police.

The American economist and Nobel laureate James Heckman has found that quality early education helps break the cycle of generational poverty. And skills developed through quality early childhood education can last a lifetime.

Last week’s summit brought together 100 experts to help the government develop an “early years strategy”. To see what’s been happening, it helps to start with childcare, then move on to early education.

The Morrison government reduced the cost of childcare for second and subsequent children, but Anthony Albanese topped that by promising to increase the subsidy to up to 90 per cent for the first child, starting in July.

This was Labor’s biggest election promise, costing more than $5 billion a year. It has also asked the Productivity Commission to review the childcare system and asked the Australian Competition and Consumer Commission to develop a mechanism to regulate the cost of childcare.

But cost is only one problem. Many families have trouble finding a place for their kid. Research by Victoria University’s Mitchell Institute has found that more than a third of Australians live in regional and rural areas where three children vie for each place. Areas with the highest fees usually have the highest availability of places, suggesting private providers go not only where the demand is, but also where they’re likely to make higher profits.

I trust you noticed that all those wonderful benefits came from quality care. Successive federal governments have worked to increase the quality of childcare, including improved ratios of staff to kiddies. This helps explain why the cost of childcare keeps rising.

Politicians and economists tend to see the main benefit from more and cheaper childcare as allowing more women to get paid employment. This is about gender equity, not just a bigger economy.

But another reason childcare keeps getting dearer is the push for childcare to be about early education – “play-based learning” – not just child minding. This means getting better qualified carers, including a proportion with teaching qualifications.

The other part of the early education push is the introduction of “universal” preschool education for 4-year-olds. The previous government started this some years ago, with the states. Now the push is for preschool to be extended to 3-year-olds. And last year the Victorian and NSW premiers announced plans for greatly increased early childhood spending, particularly on preschools.

What more the feds will be doing, we’ll know when they produce their early years strategy. But whatever the plan, it’s unlikely to succeed unless it involves higher pay for childcare workers – paid for by the government, not parents.

Considering the many benefits of early education, however, the extra cost should be seen as an investment in our children’s wellbeing. Not to invest what’s needed would be to “leave money on the table”, as economists say.

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The knowledge economy is behind the soaring price of land

Over the two centuries and more that people have made a serious study of how the economy works, economists have fallen in and out of love with land. At first, they thought it was at the centre of everything, then they decided it wasn’t terribly important. But the wheel may be turning again. In a major speech last month, the Grattan Institute’s Brendan Coates criticised his profession for its “longstanding intellectual neglect of the economics of land”.

You don’t have to think about housing affordability for long to realise it is not actually the high cost of building a house that’s the problem, it’s the high cost of the land it’s built on.

But why is the cost of land rising much faster than the economy is growing? And why don’t economists take more interest in why this is happening and what we could do about it?

Coates began the annual Henry George Lecture by summarising the history of economists’ waxing and waning interest in land as a resource used to produce goods and services.

The first economists – the Physiocrats – thought of almost nothing other than land, he says. Land was fundamental: agricultural labourers were the source of economic growth, while landlords simply commandeered what the workers produced and flowed it through to the rest of the economy.

The next generation of economists, the “classical” economists of the 18th century, broadened their focus to studying the complex interaction of three “factors of production”: land, labour and (physical) capital.

Adam Smith, a Scotsman known as the father of economics, argued that the “division of labour” – workers specialising in different occupations – and technological innovation were what drove economic growth. But land was still central.

David Ricardo, an English member of parliament, argued that landlords were simply the lucky beneficiaries of land’s natural scarcity (any country has only a fixed amount of it) and its productive capacity, to produce food and fibre and even valuable energy and minerals, Coates says.

And Henry George, the last great classical economist, argued that the rental income enjoyed by landlords must be socialised by taxing the unimproved value of all privately owned land.

Do that, and you wouldn’t need any other taxes. George campaigned hard, but never persuaded any government to follow his advice.

Coates says we “would have done well – possibly much better than we have done – if we’d heeded the lessons of Henry George and paid more attention to the economics of land”.

But in the 19th century the classical economists were replaced by the neo-classical economists, who were a lot less interested in land. And in 1956, the great American economist Robert Solow developed a theory of economic growth, which held that it was improvements in the efficiency with which labour and physical capital (machines and buildings) were combined that drove our standard of living.

The role of land in production - and in inequality - disappeared from the theories economists devised to explain the world, Coates says. Instead, land was treated as just another form of physical capital.

Coates says that “the shifting focus on land in the history of economic thought reflects the changing nature of the economies that economists were trying to explain”.

The Physiocrats observed a world dominated by agriculture. It was obvious that the ownership and use of land determined what got produced, in what quantities. And who got what.

The classical economists watched this world transition through the Industrial Revolution, and the neo-classical economists developed theories for a world that had made that transition.

Economic power started to gravitate towards those who owned capital (whether physical or financial) and away from those who owned land. Agricultural production made way for industrial production.

For most of the 20th century, the neglect of land was of little consequence. More important was the amount of capital invested (to make labour more productive) and the pace of innovation (ditto).

“But as the advanced economies of the world have transitioned again – from manufacturing to services – land is back,” Coates says. Economies powered by intangible capital – how much you know; how much information you can gather – strive or stagnate on the ability of individuals to come together and combine their knowledge and skills.

As any real estate agent will tell you, it’s about “location, location, location”. In Australia, it’s the Grattan Institute that’s done most to help us see that, these days, it’s big cities that drive the economy.

Eighty per cent of the value of all goods and services produced in Australia is generated on just 0.2 per cent of our land. Economic activity is concentrated in CBDs, with the Sydney and Melbourne CBDs accounting for 10 per cent of all economic activity in Australia – more than three times the contribution of agriculture.

This concentration reflects the rise in knowledge-intensive services, clustered together at the hearts of our major cities. The willingness of businesses to pay high rents to locate in the CBDs of our big cities shows the value they gain from access to high-skilled workers and proximity to suppliers, customers and partners.

Similarly, the willingness of workers to pay much higher prices for homes located close to those employment centres shows they, too, see value in being crammed in. Our experience of working from home during the pandemic has changed this a bit – three days in the office rather than five – but not a lot.

All this helps explain why house prices have risen about five times faster than average full-time earnings over the past 25 years. And it means the price of land is a much bigger factor in the economy than it used to be.

It’s leaving existing home owners seemingly much better off, but aspiring home owners much worse off. It’s the product of a clash between the rise of the knowledge economy and our longstanding attitudes towards the taxing and regulation of land.

It should not be beyond the wit of economists to come up with a better approach.

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A damaged environment leads to an unlivable economy

Economists are paid to worry about the economy, which they usually define fairly narrowly. And, like all specialists, they tend to overemphasise what they know so much about and underrate everything else.

Karl Marx usually gets the credit for saying that, in the economy, “everything’s connected to everything else”. The most conservative economist would agree. The economy is circular because what’s an expense to you, is income to me.

But what applies inside the economy applies equally outside it. Everything inside what we call the economy is connected to everything outside it. What is outside it? The rest of the world – the natural world.

The “economy” sits inside what we call “the environment”. Without the environment, there wouldn’t be an economy. Humans wouldn’t be here, and we wouldn’t need one.

When you step back from our daily preoccupations – at the minute, inflation and interest rates – the bigger picture reveals that economic activity – producing and consuming goods and services – mainly involves doing things to the natural environment: we clear the forest to grow food, scar the countryside to mine minerals, which we manufacture into a thousand kinds of machines.

As we get more prosperous, the population grows, our towns and cities get bigger and we clear more forest to build more houses, roads, highways and bridges. We pull more fish from the sea. We move around a lot. And we power it all by digging up fossil fuels and burning them.

As the population’s grown, but more particularly as consumption per person has multiplied, we’ve done more and more damage to the environment.

But here’s the trick: we’ve hit the environment so hard, it’s started punching back.

That’s why the most important economic event of recent times is not the latest rise in interest rates, it’s last month’s State of the Environment report – whose release was delayed until we found a government with the courage to break the bad news.

The report’s significance is not only its rollcall of how much damage we’ve done so far, but its account of the way that damage is damaging the humans who’ve done it.

We’ve been damaging the environment in many ways – loss of habitat and species, introduction of invasive animals and plants, pollution and waste disposal, salinity and other damage to soil and waterways, overfishing – but the greatest single source of damage, of course, is climate change.

The five-yearly report brings the bad news that climate change is compounding all the other problems. And whereas previous reports warned of future damage from climate change, this one shows it’s already happening – and getting worse.

It documents the extreme floods, droughts, heatwaves, storms and bushfires that have occurred across Australia in the past five years. The immediate effects have been millions of animals killed and habitats burnt, enormous areas of reef bleached, and people’s livelihoods and homes lost.

But there are many longer-term effects still to play out. Extreme conditions put immense stress on species already threatened by habitat loss and invasive species. An extreme heatwave in 2018, for example, killed 23,000 spectacled flying foxes, making them an endangered species.

Many of our ecosystems have evolved to rebound from bushfires. But now that the fires are coming more often and are more intense, the bush doesn’t have enough time to recover, which scientists expect will make it weedy – only those species that live fast and reproduce quickly will thrive.

But enough about plants and animals, what about us? While cyclones, floods and bushfires directly destroy our homes and landscapes, Professor Emma Johnston, of Sydney University, an author of the report, writes that heatwaves kill more people in Australia than any other extreme event.

Heatwave intensity has increased by a third over the past two decades. And climate change worsens air quality through dust, smoke and emissions. The Black Summer of 2019-20 exposed more than 80 per cent of our population to smoke, killing about 420 people.

As Liz Hanna and Mark Howden, of the Australian National University, remind us, clean air is just one of the “ecosystem services” the environment provides to you and me in the economy. Another is clean food. A lot of our recent complaints about the cost of living – the high cost of meat and vegetables, the mythical $10 iceberg lettuce – come from the delayed effect of the drought and the recent effect of the floods.

Yet another service is clean water. But many country towns had to truck in water during the last drought. Land clearing affects water quality. Run-off from agriculture damages water ecosystems and encourages algal bloom and species loss. More than 4 million people depend on the Murray-Darling rivers for their water, but the catchments are rated as poor or very poor.

Finally, the report reminds us that contact with (healthy) nature is associated with mental health benefits, promotes physical activity and contributes to overall wellbeing. Biodiversity and green and blue spaces in cities are linked to stress reduction and mood improvement, increased respiratory health, and lower rates of depression and blood pressure. Enjoy ’em while they last.

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Why interest rates are going up, and won't be coming down

It’s time we had a serious talk about interest rates. And, while we’re at it, inflation. Someone in my job knows it’s time to talk turkey when the man in charge of rates, Reserve Bank governor Dr Philip Lowe, decides to go on the ABC’s 7.30 program to talk about both.

There’s much to talk about. Why are interest rates of such interest to so many (sorry)? Why do some people hate them going up and some love it? How do interest rates and the inflation rate fit together? Why do central banks such as our Reserve keep moving them up and down? When rates go up, they normally come back down – so why won't that happen this time?

Starting with the basics, interest is the price or fee that someone who wants to borrow money for a period has to pay to someone who has money they’re prepared to lend – for a fee.

Legally, the “person” you’ve borrowed from is usually a bank, while the person with savings to lend deposits them with a bank. But economists see banks as just “intermediaries” that bring borrowers on one side together with ordinary savers on the other.

The bank charges borrowers a higher interest rate than it pays its depositors. The difference reflects the bank’s reward for bringing the two sides together, but also the risk the bank is running that the borrower won’t repay the debt, leaving the bank liable to repay the depositor.

You see from this that interest is an expense to borrowers, but income to savers. This is why there’s so much arguing over interest rates. Borrowers hate to see them rise, but savers hate to see them fall. (The media conceal this two-sided relationship by almost always treating rate rises as bad.)

Now we get to inflation. Economists think of interest rates as having two components. The first is the compensation that the borrower must pay the saver for the loss in the purchasing power of their money while it’s in the borrower’s hands. The second part is the “real” or after-inflation interest rate that the borrower must pay the saver for giving up the use of their own money for a period.

This implies that the level of interest rates should roughly rise and fall in line with the ups and downs in the rate of inflation – the annual rate at which the prices consumers pay for goods and services (but not for assets such as shares or houses) are rising.

This explains why, when the inflation rate was way above 5 per cent throughout the 1970s and ’80s, interest rates were far higher than they’ve been since.

Now it gets tricky. Central banks have the ability to control variable interest rates by manipulating what’s known confusingly as the “overnight cash rate”. This “official” interest rate forms the base for all the other (higher) interest rates we pay or receive.

The Reserve Bank uses its control over this base interest rate to smooth the ups and downs in the economy, trying to keep both inflation and unemployment low.

When it thinks our demand for goods and services is too weak and is worsening unemployment, it cuts interest rates to encourage borrowing and spending. When it thinks our demand is too strong and is worsening inflation, it raises interest rates to discourage borrowing and spending.

The pandemic and the consequent “coronacession” caused the Reserve (and all the other rich-country central banks) to cut the official interest rate almost to zero.

The economy has bounced back from the lockdowns and is now growing strongly, with very low unemployment and many vacant jobs. But now we’ve been hit by big price rises from overseas, the result of supply bottlenecks caused by the pandemic and a leap in oil and gas prices caused by the war on Ukraine, plus the effect of climate change on local meat and vegetable prices.

As Lowe explained to Leigh Sales on 7.30, these are once-only price rises and, although he expects the inflation rate to reach 7 per cent by the end of this year, it should then start falling back toward the Reserve’s target inflation rate of 2 to 3 per cent.

His worry is that the economy’s capacity to produce all the goods and services being demanded is close to running out – and already has in housing and construction. This raises the risk that the rate of growth in prices won’t fall back as soon as it should.

This is why Lowe’s started raising the official interest rate from its pandemic “emergency setting” near zero – zero! – to a “more normal setting”. Such as? To more like 2.5 per cent, he told Sales.

Why 2.5 per cent? Because that’s the mid-point of his inflation target.

Get it? Interest rates are supposed to cover expected inflation plus a bit more. Once Lowe’s able to get them back up to that level without causing a recession, they won’t be coming back down until the next pandemic-sized emergency.

A base interest rate of zero was never going to be the new normal. The nation’s saving grandparents would never cop it.

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Economic times are tricky, but they're far from 'dire'

It’s a funny thing. The easily impressionable are packing down for imminent recession, while the economic cognoscenti are fretting that the economy is “overheating”. Unfortunately, the two aren’t as poles apart as you may think. Even so, both groups need to calm down and think sensibly.

There was much talk of recession last week as the sharemarket dropped sharply. We dropped because Wall Street dropped. It dropped because the thought finally occurred that if the US Federal Reserve whacks up interest rates as far and as fast as the financial markets are demanding, high inflation might be cured by putting the US into recession.

It’s true that when central banks try to cool an overheating economy by jamming on the interest-rate brakes, they often overdo it and precipitate a recession.

But a few other things are also true. One is Paul Samuelson’s famous quip that the sharemarket has predicted nine of the past five recessions. As the pandemic has taught us to say, it has a high rate of “false positives”. Assume that a sharemarket correction equals a recession, and you’ll do a lot more worrying than you need to.

In truth, the chances of a US recession are quite high. But another truth is that the days when a recession in the US spelt recession in Australia are long gone. Our financial markets are heavily influenced by America, but our exports and imports aren’t. Remember, during our almost 30 years without a serious recession, the Yanks had several.

China, however, is a different matter, and its continuing strength is looking dodgy. But even though a Chinese recession would be bad news for our exports, of itself that shouldn’t be sufficient to drop us into recession.

That’s particularly so because much of the blow from a drop in our mining export income would be borne by the foreigners who own most of our mining industry. It would be a different matter if modern mining employed many workers, or paid much in royalties, income tax and resource rent tax.

Remember, too, that contrary to what Paul Keating tried telling us, all recessions happen by accident. The politician who thinks a recession would improve their chances of re-election has yet to be born. And few central bank bosses think a recession would look good on their CV.

They occur mainly because an attempt to use higher interest rates to slow an overheated economy goes too far and the planned “soft landing” ends with us hitting the runway with a bump. It follows that the greatest risk we face is that the urgers in the financial markets (the ones whose decision rule is that whatever the US does, we should do) will con the Reserve Bank into raising interest rates higher than needed.

But I’m sure Reserve governor Dr Philip Lowe is alive to the risk of overdoing the tightening.

He mustn’t fall for the claim that, because a combination of fiscal stimulus and an economy temporarily closed to all imported labour has left us with a record level of job vacancies and rate of labour under-utilisation of 9.6 per cent, the economy is “red hot”.

Is it red hot when almost all the rise in prices is imported inflation caused by temporary global supply constraints? Or when the latest wage price index shows wages soaring by 2.4 per cent a year and all the Reserve’s tea-leaf reading shows wages rising by three-point-something? And (if you actually read it right, which most of the media didn’t), last week’s annual wage review awarded the bottom quarter of employees a pay rise of 4.6 per cent, not 5.2 per cent.

Is it red hot when employers are reported to be offering bonuses and non-economic incentives to attract or retain staff? That is, when they aren’t so desperate they feel a need actually to offer higher wage rates. Or is it when oligopolised businesses are still claiming they can “afford” pay rises of only 2 per cent or so and, predictably, there’s been no talk of strikes?

Is an economy “overheating” and “red hot” when real wages are likely to fall even further? That is, when the nation’s households will be forced by their lack of bargaining power to absorb much of the temporary rise in imported inflation (plus, the delayed effects of drought and floods on meat and vegetable prices)?

And, we’re asked to believe, households will be madly spending their $250 billion in excess savings despite the rising cost of living, falling real wages, rising interest rates, talk of imminent recession and falling house prices. Seriously?

No, what’s most likely isn’t a recession, just a return to the weak growth we experienced for many years before the pandemic, thanks to what people are calling “demand destruction” by our caring-and-sharing senior executive class.

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Why Albanese needs to protect capitalism from the capitalists

One of the first things Anthony Albanese and his cabinet have to decide is whether the government will be “pro-business” or “pro-market”. If he wants to make our economy work better for all Australians, not just those at the top of the economic tree, Albanese will be pro-market, not pro-business – which ain’t the same as saying he should be anti-business. Confused? Read on.

It’s clear Albanese wants to lead a less confrontational, more consultative and inclusive government – which is fine. He’ll bring back into the tent some groups the Morrison-led Coalition government seemed to regard as enemies: the unions, the universities and the charities.

Conversely, it’s obvious he wants to retain big business within the tent – as, of course, it always is with the Liberals. Business is so powerful the sensible end of Labor never wants to get it offside.

Trouble is, over the years in which the Hawke-Keating government’s commitment to “economic rationalism” degenerated into “neo-liberalism”, big business got used to usually getting its own way – even if the process needed to be lubricated with generous donations to party funds.

If Albanese is genuine in wanting to govern for all Australians, he’ll have to get big business used to being listened to but not blindly obeyed. Which means he and his ministers will have to resist the temptation of having the generous donations diverted in the direction of whichever party happens to be in power.

Labor could do worse than study a recent speech, Restoring our market economy to work for all Australians, by the former boss of the Australian Competition and Consumer Commission, Rod Sims. He is now a professor at the Australian National University’s inestimable Crawford School of Public Policy, home to many of the nation’s most useful former public servants.

Sims starts with an important disclaimer: “I am a strong proponent of a market economy. All the alternatives do not work well. Further, our market economy has delivered significant benefits to all Australians.

“For it to endure, however, it needs improvement. Without this, it and our society will be under threat.”

Couldn’t have said it better myself. Sometimes people criticise an institution not because they hate it, but because they love it and don’t want to see it go astray. And capitalism is too important to the well-being of all of us to be left to the capitalists.

So, what’s the problem? “Running a market economy, where companies are motivated by profit, can only work as expected if there is sufficient competition, and we don’t have this now. We currently have too few companies competing to serve customers in the markets for many products; we need policies that promote competition, not thwart it,” Sims says.

A market-based economy is one where decisions regarding investment, production and distribution to consumers are guided by the price signals created by the forces of supply and demand, he explains.

But here’s the key proviso on which the satisfactory functioning of such an arrangement is based: “An underlying assumption is that there are many suppliers competing to meet consumer demands.”

Right now, that assumption isn’t being met. Sims quotes Martin Wolf, of the Financial Times, saying “what has emerged over the last 40 years is not free-market capitalism, but a predatory form of monopoly capitalism. Capitalists will, alas, always prefer monopoly. Only the state can restore the competition we need.”

What? Wolf is some kind of socialist? Of course not. Sims puts it more clearly: “A market economy also needs the right regulation in place so that companies pursue profit within clear guardrails.” We need some changes to Australian consumer law to provide these guardrails, particularly an unfair practices provision.

Market concentration – meaning there are only a few dominant companies seeking to meet the needs of consumers in many product markets – is high in Australia. “Think banking, beer, groceries, mobile service providers, aviation, rail freight, energy retailing, internet search, mobile app stores and so much more,” Sims says.

He quotes the Harvard economist Michael Porter, a corporate strategy expert, writing as long ago as 1979 that companies achieve commercial success by finding ways to reduce competition, by raising barriers to entry by new players, by lowering the bargaining power of suppliers including their workforce [No! he didn’t include screwing their own workers, did he?] and by locking in the consumers of their products and services.

“Companies don’t want markets . . . with many suppliers all with relatively equal bargaining power,” Sims says. “Instead, what firms seek is market power where they can price, or pay their suppliers, as they want, without being constrained by other competing companies.

“They seek above-normal profits based on using some form of market power.”

This is not controversial, he says. “Every businessperson would agree. None wants to work in a competitive market where they simply seek to outperform their competitors. They want an edge from some form of market power.”

Too much market power in our economy can cause a range of harms to many Australians and to our society. “The most obvious harm is higher prices, which occur particularly when supply is limited relative to demand.

“When supply is plentiful, however, market power means pressure comes on workers and other suppliers.”

Sims points to the way the profits share of national income has been rising at the expense of the wages share. He also notes concerns about the lack of innovation in Australia, as well as our low productivity.

Guess what? When so many markets are dominated by a few big firms, the resulting lack of competitive pressure reduces the incentives to invest, create new products and do other things that increase productivity.

The message for the new government is clear: keep giving big business what it wants – weak merger and competition laws, plus prohibitions on union activity – and the economy will continue performing poorly. Profits will keep growing while household income shrinks.

And it will prove what the Liberals have always said: Labor’s no good at running the economy.

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Labor mustn't be panicked into doing something stupid

Who’d want to be the new Treasurer, Dr Jim Chalmers? Certainly, not me. But that won’t stop me giving him a shed-load of free advice. Starting now.

As Chalmers sees it, the economy he’s inherited is in “dire” straits. Everywhere he looks there’s another problem. First, “skyrocketing” inflation.

Second, falling real wages as “a consequence of almost a decade of the deliberate undermining of pay and job security, now coming home to roost in the form of a full-blown cost-of-living crisis”.

And third, a budget “heaving with more than $1 trillion in debt” and worse (though he doesn’t mention it), a budget projected to stay in structural deficit for as far as the eye can see, meaning the debt continues to grow in dollar terms, and falls relative to the growing size of the economy only after a delay, and only slowly.

He could have added a fourth problem: a hostile international economic environment, with a fair risk of the US falling into recession and, worse, a major trading partner – China – that’s mishandling both its response to the pandemic (think more supply-chain disruptions) and its management of the macroeconomy.

Chalmers is, of course, doing what all incoming treasurers (and chief executives) do and laying it on thick. Like Mother Hubbard, he’s discovered the cupboard is bare. Actually, he’s cleaning out the cupboards and finding all the bad stuff his predecessor hid. He’s snapping people out of the campaign fairyland, where government spending can go up while taxes go down and deficits fall.

Even so, his four big problems are real enough – and seem to be getting worse as each week passes. The latest gas crisis is a parting gift from the Liberals, arising from nine years of indecision about how the transition from fossil fuel to renewables should be managed to avoid unexpected mishaps – such as a Russia-caused leap in global fossil fuel prices.

So what should he do? Avoid being panicked by the many partisan ill-wishers and ideological barrow-pushers who would do so. He needs to think carefully about the various problems, the highest priorities, the right order in which to tackle them, their varying degrees of difficulty and urgency, and the way they interrelate - the ways he can kill two birds with one stone, or make choices to fix one problem that make another problem worse.

Chalmers should be wary of conventional thinking about problems that are of unconventional origins. Just as the “coronacession” was unlike an ordinary recession because it was caused by government-imposed restraints on the supply side rather than efforts to curb excessive demand, so he shouldn’t be using demand restraint to try to fix disruptions to supply.

Inflation problems normally arise from an overheated economy leading to excessive wage growth. The standard solution will involve cutting real wages to make labour less expensive. But we’ve had weak real wage growth for a decade.

Those ideologically opposed to fiscal stimulus tell us our stimulus has given us a red hot, inflation-prone economy – as proved by our super-tight labour market. They conveniently forget to mention that the pandemic caused us to ban all imported labour for two years, but that this supply constraint has now been lifted.

If excessive wage growth didn’t cause our high and rising prices, what did? Fiscal stimulus has caused shortages of materials and workers in housing and construction, but most of the price rises have come from external supply constraints caused by the pandemic and the war on Ukraine.

Nothing we could do can fix problems coming from the rest of the world. But we shouldn’t forget that these are once-off price increases. And those import prices will fall at some stage as pandemic disruptions are resolved and the war ends.

It’s not that simple, of course. Why not? Because our businesses don’t seem to have hesitated in passing their increased import costs through to retail prices. That’s the start not of a wage-price spiral, but price-wage spiral. And business and employer groups’ solution to the spiral is simple: allow only a token increase in wages, and inflation will come down in no time.

This is the unspoken doctrine that’s the bastard child of the economic rationalist era: give business whatever it demands and everything in the economy will be wonderful. The business lobby has become so consumed by short-sighted self-interest – so used to getting its own way – that we need a new government with the wisdom and strength to save business from its own folly.

We need a government capable of seeing what business can’t: that wages aren’t just a cost to business and an impost on profits, but also the chief source of income for the 10 million households who are the reason we have an economy and whose spending on the things our businesses produce is what generates their profits in the first place.

Screwing the workers by tolerating ever-falling real wages is a delusional way to increase profits in anything but the short term. The bigger the fall in real wages – and the government can’t stop them falling – the more Labor risks joining the US and China in recession.

This is why, in its worthy desire to keep big business in the tent, the government was wrong to ask the Fair Work Commission to increase award wages by 5.1 per cent only for “low-paid” workers – that is, only about the bottom 12 per cent of workers rather than the bottom 25 per cent.

Do you really think the 88 per cent of workers reliant on bargaining with bosses rather than a commission edict will get anything like a 5 per cent pay rise?

Former Reserve Bank governor Bernie Fraser used to say that any fool could get inflation down – all you had to do was crunch the economy. Is that what business would like? It’s certainly what the financial markets – whose model of our economy is a footnote saying “see America” – want.

As I’m sure the Reserve well understands, we need to get inflation down without causing a recession. And that means being patient about how long it takes. We were below the target range for six years; we can be above it for a few years without the sky falling.

And remember this: if we did fall into recession, the strategy of growing our way out of debt would explode. Not only would the economy be growing more slowly than the debt, the budget’s “automatic stabilisers” would reverse and the deficit would blow out, greatly increasing the debt.

On the other hand, Chalmers should be sceptical of the argument that an additional reason we need to cut the budget deficit ASAP is to reduce the need for interest rates to rise so far. Getting inflation under control is not a big ask – provided we’re patient.

The Reserve’s stated strategy is to shift the stance of monetary policy only from “emergency expansionary” to “neutral”. That is, to take its foot off the accelerator, not to jam on the brakes. This means slowly lifting the official interest rate to about 2.5 per cent, so the medium-term real interest rate is zero.

In theory, at least, this should not cause the economy to contract, nor great pain to most people with mortgages. And it would be a good thing in itself to get rates up to a level remotely approaching normal.

The real challenge for budget policy is to avoid getting us in deeper by proceeding with the stage-three tax cut in its present timing, size and form. It could be rejigged to make it more effective in relieving cost-of-living pressures for people in the bottom half.

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An economy with falling real wages can’t be “strong”

The main message from this week’s “national accounts” is that the economy isn’t nearly as Strong – Strong with a capital S – as Scott Morrison and Josh Frydenberg unceasingly claimed it was during the election campaign. In truth, it’s coming down to Earth.

According to the Australian Bureau of Statistics, real gross domestic product – the nation’s total production of goods and services – grew by 0.8 per cent during the three months to the end of March, to be up 3.3 per cent over the year.

Almost to a person, the business economists said – and the media echoed - this was “higher than expected”. But that just meant it was a fraction higher than they’d forecast a day or two before the announcement, once most of the building blocks for the figure had been revealed.

But as new Treasurer Dr Jim Chalmers has revealed, when Treasury was preparing its forecasts for the March 29 budget, it forecast growth of not 0.8 per cent for the quarter, but 1.8 per cent. Now that would have been strong.

True, if you compound 0.8 per cent, you get an annualised rate of 3.3 per cent. And that’s a lot higher than our average annual growth rate over the past decade of about 2.3 per cent.

But it’s high because the economy’s still completing its bounce-back from the two pandemic lockdowns when most people gained more income than they were allowed to go out and spend.

In other words, it’s a catch-up following highly unusual circumstances, which will stop once everyone’s caught up. It’s not an indication of what we can expect “going forward” as businesspeople love saying.

If you delve into what produced that 0.8 per cent result, you see we’re probably only a quarter or two away from returning to a much less Strong quarterly growth rate. Indeed, until we’ve fixed our problem of chronic weak wage growth, it’s likely to be quite Weak growth.

Growth during the quarter was led by a 1.5 per cent rise in consumer spending, which contributed 0.8 percentage points to the overall growth in real GDP. Pretty good, eh? Well, not really. Turns out real household disposable income actually fell by 0.9 per cent.

So the growth in consumer spending came from a 2 percentage-point fall in the rate of household saving during the quarter, to 11.4 per cent. Household saving leapt during the two lockdowns, from its pre-pandemic level of about 7 per cent.

This suggests it won’t be long before this honey pot’s been licked out. Note too, that consumer spending was very strong in the states still rebounding from last year’s lockdown – Victoria, NSW and the ACT – and particularly weak in the other states.

Why did real household disposable income fall during the quarter? Because real wages fell. The more they continue falling – as seems likely – the more continued growth in consumer spending will depend on households continuing to cut their saving. Sound sustainable to you?

The other big contributor to growth, of 1 percentage point, came from an increase in the inventories held by retailers and other businesses, caused by an easing of pandemic-related shortages of certain imported goods, including cars.

This is a sign of the economy returning to normal, but it’s a once-only adjustment, not a growth contribution that will continue quarter after quarter.

The third growth factor was a huge 2.7 per cent increase in government consumption spending, contributing 0.6 percentage points to overall growth.

Where did it come from? From increased health spending required by the Omicron variant and spending to help people affected by the floods in NSW and Queensland. Again, not something that will be happening every quarter – we hope.

With those three positive contributions adding up to a lot more than the final 0.8 per cent, there must have been some big negative contributions. Just one, actually. Net exports – exports minus imports – subtracted 1.7 percentage points.

The volume (quantity) of exports fell by 0.9 per cent, thus subtracting 0.2 percentage points from growth – mainly because the floods disrupted mineral exports.

The volume of imports jumped by 8.1 per cent, subtracting 1.5 percentage points from overall growth. Another sign of the economy returning to normal, with pandemic disruption easing and imports of cars (and their chips) resuming. Another once-off.

So, what else happened in the quarter? New home building activity fell by 1 per cent. The pipeline of new homes built up by lockdown-related government stimulus still contains homes yet to emerge, but the output has faltered because the industry’s at full capacity, with shortages of labour and materials.

Even so, with interest rates rising and house prices falling, you wouldn’t expect too many new building projects to be entering the pipeline. Housing won’t be a big part of the growth story “going forward”.

Business investment spending – mainly on plant and equipment – grew by 1.4 per cent during the quarter and by 3.6 per cent over the year. It will need to grow a lot faster than that if it’s to be a big part of the growth story.

The quarter saw the share of national income going to wages continuing to fall, while the share going to profits rose to a record high of 31.1 per cent.

On the face of it, that says the workers are being robbed. But the factors moving the respective shares are more complicated than that. For instance, all the growth in company profits during the quarter was from the mining industry. Coal, gas and iron ore commodity prices have jumped.

But a much less debatable indication that businesses are doing well at the expense of their employees comes from the 2 per cent fall in “real unit labour costs” – real labour costs per unit of production – during the quarter, and by 6 per cent since the start of the pandemic.

An economy whose strength comes from cutting its workers’ wages won’t stay Strong for long.

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Wars, floods and pestilence: these horrors have an economic upside

By profession, economists are hard-nosed and cold-blooded. The pictures we’re seeing of the death and destruction wreaked by Russia in its invasion of Ukraine are heart-wrenching. At home, seeing people perched on their roofs as floodwaters surge, or piling up the ruined contents of their homes on the footpath, makes your heart go out. But what economists see is that every disaster has its upside.

Once they’ve put on their professional’s hat, economists don’t see evil, or pain or any emotion. Feelings must be suppressed when what they need is objectivity.

They simply size up wars and natural disasters for the effect they’ll have on the economy, measured by inflation, unemployment and, above all, gross domestic product. And since GDP often ignores the destruction of buildings and other assets, but plays close attention to the building of new assets, it tends to paint an overly favourable view of events we see as disastrous.

This doesn’t make GDP an instrument of evil that should be banished. It’s simply mono-dimensional. It focuses on a vital, but narrow aspect of our lives – how much we produce, how much income we generate – while studiously ignoring all the other aspects.

When someone’s house has been declared uninhabitable, you and I see how painful and disorienting that must be for them. What an economist sees is all the jobs that will be created and income generated to build them a new one.

But until then, the family will be homeless! That’s OK. Those who provide them with somewhere to live will be earning income and employing people – provided they don’t just stay with family or neighbours. It’s not counted in GDP if no money changes hands.

GDP doesn’t measure wellbeing – and was never designed to. This is only a problem when people fall into the trap of thinking GDP is all that matters – an occupational hazard for economists.

Last week’s budget papers discussed the economic consequence of the war in Ukraine and the floods in NSW and Queensland. For such terrible events, the tone was surprisingly upbeat.

Combined, “the Russian and Ukrainian economies comprise less than 3 per cent of global GDP and less than 2.5 per cent of global trade.

“Foreign financial exposures to Russia are small, and the International Monetary Fund has assessed that sovereign [government] or bank default is not a systemic risk to global financial stability.”

Russia is, however, an important global supplier of rural, mineral and energy commodities. So the invasion has caused substantial disruption in global commodity markets, the papers say, and has the potential to significantly raise inflation and lower global growth.

“Russia produces 18 per cent of the world’s gas and 12 per cent of the world’s oil supply and, together with Ukraine, accounts for around 25 per cent of world wheat exports.” The invasion has increased the risk of supply disruptions, pushing up energy, agricultural and metals prices.

“Global supply chains are also reliant on Russian metals exports, especially palladium [a rare metal used in catalytic converters of exhaust fumes, and fuel cells], so significant supply disruption could have flow-on effects for global manufacturing supply chains.”

All economies will be affected by the rise in global commodity prices. Among the worst affected will be Europe, Japan and South Korea, which are highly dependent on imports of energy. These and other countries will suffer what economists call a “negative terms-of-trade shock” – that is, the prices of their energy imports will rise relative to the prices they get for their exports.

But, the papers say, a smaller set of countries will benefit from a “positive terms-of-trade shock” – because they are net exporters of the higher-priced energy commodities. Their consumers and businesses will pay the higher world price for the petrol and other fuels they use, but this will be greatly offset by the higher prices their producers of energy exports will be receiving.

Among this small group is one lucky country whose net energy exports are twice as great as its domestic energy use. It’s Austria. Sorry, make that Australia. As the economist Chris Richardson might say, you may be paying a lot more for your petrol, but the economy’s been kicked in the backside by a rainbow.

Turning to our floods, although it’s still raining and too soon for final figures, last week’s budget papers say that, under an arrangement where the federal government funds up to 75 per cent of the assistance provided by the state governments, the feds expect to pay more than $2 billion for income support to households, temporary accommodation and social services, about $600 million for community clean-up and recovery, and almost $700 million to businesses and farmers for repairs, new equipment and support services.

As well, the budget makes provision for $3 billion in further federal spending over the coming four years.

Moving from the budget to the economy, we’re told that the “direct economic cost” – that is, those purely monetary costs that show up in GDP – are expected to subtract about 0.5 percentage points from the growth in the nation’s real GDP during the March quarter.

What are the costs that show up in GDP? They’re mainly reduced production in the mining, agriculture, accommodation and food services, retail trade and construction industries.

You’ll be relieved to hear, however, that this 0.5 per cent overstates the net impact of the floods on real GDP over the longer term.

Why? Because “this direct cost will be partially offset by increased investment to replace and rebuild damaged housing, infrastructure and household goods”.

And here’s some good news: the reduced exports of coal caused by rain in the March quarter aren’t expected to be as bad as previous weather events, such as the floods and Cyclone Yasi in 2011.

If you find all this mercenary and distasteful, it’s not new. The arrival of World War II helped end the Great Depression. And rebuilding bombed out Europe and Japan after the war helped the rich countries grow faster than ever before – or since.

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It will take more that faith to keep the economy growing

Treasurer Josh Frydenberg says it’s time for the private sector to drive the economy’s recovery. And, this being a Liberal Party article of faith, he’s likely to keep saying it in this month’s budget and the election campaign to follow. One small problem: there’s little sign it’s happening.

Last week’s national accounts for the December quarter were a reminder that the economy’s living on borrowed time and stored heat. Both households and businesses are cashed up as a result of “fiscal stimulus” – government income support – and income they weren’t able to spend during lockdowns.

It’s estimated that households have an extra $200 billion or more waiting to be spent. As it is spent, private consumption will continue growing strongly in real terms. But, absent further lockdowns, there’ll be no more special support from the budget. No more JobKeeper payments and the like, no more grants to encourage home building, and a looming end to tax breaks to encourage business investment in equipment and construction.

The two main things we need to achieve continuing strong economic growth (by which I mean growth in income per person, not just more immigration) is strong real growth in household consumption spending and business investment spending.

Trouble is, last week’s figures offered little assurance that either requirement will be forthcoming. Starting with business investment, Kieran Davies, of Coolabah Capital, reminds us that (even after including intangible investment in software and research and development) it’s presently at the “extraordinarily low” level of 10 per cent of gross domestic product, similar to the lows it reached in the recessions of the 1970s and 1990s.

It may be about to take off – or it may not be. It’s hard to think why a take-off is likely. Davies reminds us that a major benefit from a big lift in business investment would be a lift in the productivity of labour, as workers were supplied with the improved equipment they need to be more productive.

Indeed, you can turn the argument round the other way and wonder if the weak rates of business investment over the past decade or so do much to help explain why productivity has improved so little over the period.

Even the most tightwad employer must agree that improved labour productivity means wages can rise faster than prices without adding to inflation.

And if we want to see consumer spending, which accounts for well over half of GDP, continuing to grow strongly once all the money households saved during the pandemic has been spent, rising real wages are the only thing that will do it.

Trouble is, the (temporary) surges in consumer spending whenever we end a period of lockdown have given the impression the economy is booming, while concealing the truth that, after allowing for inflation, wages have been falling, not rising.

This is also reflected in last week’s news from the national accounts that “non-farm real unit labour costs” – which, by comparing the change in firms’ real labour costs with the change in the productivity of that labour, reflect the division of surplus between labour and profits – have fallen by 3 per cent since the start of the pandemic.

This should not come as a surprise when you remember that, in early 2020, when we feared the battle to control the virus would send us into a deep and lasting recession, most businesses moved immediately to impose a wage freeze.

Worried about whether the deep recession would sweep away their jobs, workers and their unions accepted the necessity of the freeze.

But that’s not the way things turned out. The pandemic wasn’t nearly as bad as epidemiologists first expected it to be, vaccines turned up much earlier than had been hoped, lockdowns were often short and intermittent, and unprecedented fiscal stimulus shifted much of the cost of the lockdowns off private businesses’ profit and loss accounts and onto the public sector’s budgets.

In the main, private sector profits have held up surprisingly well.

So the key issue of whether consumer spending, and thus the wider economy, can continue growing strongly after households have finished the spending repressed during the lockdowns is what happens to wage growth. And that comes down to three questions.

First, will employees get outsized pay rises this year to compensate them for the wage freeze that turned out not to be needed?

Second, will employees also get pay rises big enough to cover all the recent increase in living costs they face – higher petrol prices and the rest – or will employers, public as well as private, ask them to “take one for the team” one more time? If so, real wages will fall further and future consumer spending will be stuffed.

Third, will the econocrats’ strategy of running a super-tight labour market force tight-fisted employers to increase wages, as the only desperation measure able to attract the workers they need?

Or will the labour shortages gradually dissipate now our border’s been reopened to overseas students, backpackers and skilled immigrants on temporary visas?

Meanwhile, the man who should be solving our cost-of-living/weak wages problem will be blustering on about the private sector taking over the running. If the Opposition can’t make this the central focus of the election campaign, it deserves to lose. It, too, would be bad at managing the economy.

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The plague hasn’t wounded the economy, but the boom won’t last

The pandemic has caused much pain – physical, financial and psychological – to many people. But what it hasn’t done is any lasting damage to the economy and its ability to support people wanting to earn a living.

That’s clear from this week’s “national accounts” for the three months to the end of December, with the Australian Bureau of Statistics revealing the economy’s production of goods and services – real gross domestic product – rebounding by 3.4 per cent, following the previous quarter’s contraction of 1.9 per cent, caused by the lockdowns in NSW, Victoria and the ACT.

Despite those downs and ups, the economy ended up growing by 4.2 per cent over the course of last year. It was a similar story the previous year, 2020, when despite the nationwide lockdown causing the economy to contract by a massive 6.8 per cent in the June quarter, it began bouncing back the following quarter.

Over the two years of the pandemic, the economy’s ended up 3.4 per cent bigger than it was before the trouble started.

Be under no illusion, however. The economy would not have been able to bounce back so strongly had the federal government not spent such huge sums topping up the incomes of workers and businesses with the JobKeeper wage subsidy, the temporary increase in JobSeeker benefits, special tax breaks for business (including to encourage them to invest in plant and equipment) special incentives for new home-building, and much else. The state governments also spent a lot.

The Reserve Bank also cut interest rates – from next-to-nothing to nothing – and bought a lot of government bonds, but I find it hard to believe this made a big difference, except to house prices and home building.

It’s true that these figures for GDP and its components don’t include the effects of the Omicron wave, which came mainly in the first half of January. But by now it’s pretty clear its effect on the economy was fairly small. Of course, we may not be finished with the Greek alphabet.

None of this is to deny that the pandemic has done lasting damage to some individual workers, businesses and industries. Overall, however, the economy’s in surprisingly good shape. And this is confirmed by turning from the national accounts to the jobs market.

We have 270,000 more people in jobs than we did before the pandemic, and both unemployment and underemployment are at 13-year lows, while the number of job vacancies is at a record high.

This remarkable achievement is partly the consequence of shortages of young, less-skilled workers, caused by our closed border, however. Those shortages will gradually go away now the border’s been reopened.

Unsurprisingly, the detailed figures show that most of the growth during the quarter came from a rebound in the two unlocked states, NSW and Victoria, plus the ACT.

More surprisingly, most of the growth came from a rebound in consumer spending in former lockdown area, which rose by 9.6 per cent, compared with 1.6 per cent in the rest of the country.

The only other positive contribution to growth in the quarter was a rise in the level of business inventories – meaning the rest of the economy was holding it back.

Spending on new housing and alterations fell by 2.2 per cent in the quarter, mainly because of temporary shortages of workers and materials.

The government’s stimulus program has ended, but the industry still has many new houses in the pipeline. However, Thursday’s news of a 28 per cent collapse in the number of new residential building approvals in January makes you wonder how long the housing industry will keep contributing to growth.

Business investment in new equipment and construction also fell during the quarter. Businesses say they’re expecting to increase their spending significantly this year but, as Kieran Davies, of Coolabah Capital, has noted, “companies find it hard to forecast their own investment expenditure”. And the government’s tax incentives won’t last forever.

The jump in consumer spending came despite a fall in households’ disposable income, caused by a decline in assistance from government. Thus, to cover the increased spending, households had to cut their rate of saving during the quarter from almost 20 per cent of their disposable income to 13.6 per cent.

What’s been happening is that households save a huge proportion of their income during lockdowns (because they can’t get out of the house to spend it), but cut their rate of saving when the lockdown ends and spend much more than usual as they catch up on things and services they’ve been waiting to buy.

Even so, a saving rate of 13.6 per cent is about twice the normal rate - meaning households still have a lot of money stashed in bank accounts – more than $200 billion – that they’ll be able to spend in coming months.

Most of this is money they’ve earnt in the normal way, but much of it is also money that’s come to them in special assistance from the government.

It’s mainly because of all this extra money waiting to be spent that the Reserve Bank is forecasting that, after contracting by about 1 per cent in 2020 and growing by 4 per cent in 2021, the economy will grow by a bit more than 4 per cent this year.

Remember, however, that the economy usually grows by only about 2.5 per cent a year. So what looks like booming growth last year and this, is really just catch-up from the temporary effects of lockdowns.

We simply can’t – and won’t – keep growing at the rate of 4 per cent a year. That’s why the Reserve is expecting growth to slow sharply to a more-normal 2 per cent next year, 2023.

Most of the extra money households are holding may have been spent by the end of this year. And the forecast for 2023 assumes we’ll be back to wages growing a bit faster than the cost of living – which has yet to happen.

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