Why our standard of living will be rising more slowly

You could call it gloom, or call it realism, but the likelihood is the economy will be growing more slowly from now on.

And we’re talking not just the next year or two – where the Reserve Bank’s rapid rise in interest rates means if we don’t go backwards, we’ll have been let off lightly – but the next maybe 40 years.

No one – not even economists – knows what the future holds, of course. But this long-term slowing is the considered guess of the secretary to the Treasury, Dr Steven Kennedy, who this week gave us his summation of the Treasury’s recent intergenerational report, which makes largely mechanical projections – not hard-and-fast forecasts – for the economy over the 40 years to 2063.

 Kennedy says the projections are “illustrative”. A key assumption on which they’re based, that present government policies don’t change, means the projections demonstrate “the longer-term implications of our current path”.

The report’s “aim is to avoid the risks projected … through ongoing improvement and reform of policy settings”.

Even so, I think we’re justified in concluding that the slower growth the report projects is more likely to eventuate than either unchanged or faster growth. That’s because so many of the factors likely to affect our future growth are beyond the government’s control.

The report projects that real gross domestic product – the nation’s total production of goods and services – having grown by an average of 3.1 per cent a year over the past 40 years, will slow to growth of 2.2 per cent a year over the coming 40 years.

How would this slowdown be explained? The Treasury’s standard way of analysing economic growth is to break it up into the three main drivers of growth – known as “the three Ps”: growth in the population, growth in the population’s participation in the labour force, and growth in the productivity of the workforce.

Notice how people-centred this way of chopping up economic growth is?

First. Population. Whereas our population grew at an average rate of 1.4 per cent a year over the past 40 years, it’s projected to grow by just 1.1 per cent over the coming 40.

These days, “natural increase” – births minus deaths – accounts for only about 40 per cent of the growth in our population, with “net overseas migration” accounting for the remaining 60 per cent.

The Treasury projects a further slow decline in our “fertility rate” – the number of births per woman – which has long been well below the 2.1 children “replacement rate” needed to hold the population steady over the years.

So we’ve long used high immigration to keep the population growing. Net migration fell sharply when we closed our borders during the pandemic. It has surged since the borders were reopened, but the Treasury expects it to fall back to 235,000 people a year once the surge has passed.

This level is what the Treasury projects for the rest of the years to 2063 – meaning that fixed number would fall as a percentage of the growing population. Even so, the population is expected to exceed 40 million in the early 2060s.

It’s just a projection, but I don’t have trouble believing immigration levels will decline rather than increase in the coming years. With all the rich countries – and China - having fertility rates well below the replacement rate, I can see far more competition for immigrants than there has been, especially since we only want skilled immigrants.

This expected slowdown in immigration means the overall size of the economy wouldn’t be growing as fast as it has been, but that doesn’t necessarily mean those of us who are already here will be worse off. That depends less on the economy’s overall growth and more in what’s happening to growth in GDP per person.

The report projects that, whereas real GDP per person grew by 1.8 per cent a year on average over the past 40 years, it will slow to 1.1 per cent a year over the coming 40.

Ahh. So, not just slower growth in the economy, but a much slower rate of improvement in our material standard of living. We’d still be getting more prosperous, but at a rate so small that it would be hard to notice.

And the problem must be coming from the other two Ps – participation and productivity improvement.

At present, the “participation rate” – the proportion of the working-age population that’s either in work or actively seeking it – is the highest it’s ever been, at 66.6 per cent, but the Treasury projects it will have fallen to 63.8 per cent by 2063.

Why? Because the proportion of the population aged 65 and over is projected to rise from 17 per cent to 23 per cent. So population ageing means more people will be too old to work.

But this will be countered to an unknown extent by more women of working age taking paid employment, and a healthier post-65 population choosing to keep working, even if only a few days a week.

However, most of the slowdown in GDP growth per person is explained by the expectation that the rate of improvement in the productivity of labour will be slower.

Whereas productivity improved at an average rate of 1.5 per cent a year over the past 30 years, it’s improved by only 1.2 per cent a year over the past 20 years – and that’s the rate the Treasury has projected over the coming 40 years.

There are plenty of reasons to expect productivity improvement will become harder to achieve. Just one is the greater share of GDP coming from the provision of labour-intensive services and the lesser share from the capital-intensive production of goods. It’s a lot easier to make machines more productive than do the same for people.

Finally, another reason for expecting population, participation and productivity to be weaker in coming decades is that various other rich countries’ experience is leading them to expect the same.

Read more >>

'Planetary boundaries' set the limits of economic freedom

One of the most important developments in economics is something in which economists had no hand: the identification of the environmental limits which humans, busily producing and consuming, cross at their peril.

Earth has existed for about 4 billion years and humans have lived on Earth for about 200,000 years. For almost all of that time we were hunters and gatherers, but 10,000 to 12,000 years ago we settled down, to farm and create civilisation.

It’s probably no coincidence that, for about that time, Earth has enjoyed a stable climate, with no more ice ages nor period of great heat, in which palms grew in Antarctica. This is the geological epoch called the Holocene, in which we live – although it may be ruled that we’ve moved to the Anthropocene, a new epoch in which the human species has made major alterations to the planet.

In its modern form, economics can be dated to 1776, when Adam Smith published The Wealth of Nations. Beliefs about how the economy works were well-defined by the time Alfred Marshall published Principles of Economics in 1890.

The point is that all economic activity – all the efforts of humans to earn a living – both depends on the natural environment and adversely affects it. By 1900, there were only about 1.6 billion humans on the planet, not enough to do much damage.

If we wrecked some area, we could just move to somewhere that hadn’t been wrecked, while the first bit gradually recovered.

So, at the time conventional economics was established, it was perfectly sensible to assume that the environment’s role in economic activity could be taken for granted. It was just there and it always would be. It was, as economists say, a “free good”.

When, from the 1700s, we started burning fossil fuel – coal, oil and gas – for heat, light and energy, we had no reason to worry that one day it might run out. It certainly never occurred to us that this might end up having an effect on the climate.

It took many decades before scientists began telling us that all the things we were doing to improve our lives – cutting down forests, damming rivers, drilling for water, ploughing, fertilising crops, fishing with nets – were damaging the soil, causing erosion, killing species, lowering the water table, and damaging the environment in other ways.

However, in just the past century or so, the world’s population has gone from 1.6 billion to 8 billion. Every extra human does a bit more damage to the environment. But that’s not the main thing. The main thing that’s changed is our use of advances in technology to hugely increase our standard of living and, in the process, massively increase the damage we’re doing to the environment.

Which brings us to “planetary boundaries”. In 2009, the Swedish scientist Johan Rockstrom and a scientist from the Australian National University, the late Will Steffen, with many helpers, established a framework listing the key categories of environmental damage, and estimating the amount of damage that could be done to each before the risk increased that “the Earth system” could no longer recover.

A second update of these estimates, led by an American oceanographer based in Copenhagen, Katherine Richardson, was released last month. With the ANU’s Professor Xuemei Bai, Richardson has written an article explaining the planetary boundaries.

There are nine boundaries. Three of them cover what we take from the ecological system: loss of biodiversity (extinction of species), loss of fresh water (pumping too much water from rivers and aquifers) and land use (deforestation).

Something economists didn’t know – or didn’t realise affected them – is that the laws of physics say we can never truly get rid of anything that exists on Earth.

All we – or the ecosystem – can do is change the form of the thing. Water can evaporate, but it’s still up in the clouds, for instance. We can cut down a tree, but as it slowly sinks into the dirt, it releases the carbon dioxide it had previously taken up.

This means that all our economic activity leaves in its wake a lot of waste. Not just landfill, but in many other forms.

So, the remaining six boundaries concern the waste our activity greatly adds to what would have occurred naturally. They are: greenhouse gases which cause climate change, ocean acidification (carbon absorbed by the sea), emission of chemicals that deplete the Earth’s ozone layer, “novel entities” (synthetic chemicals such as plastics, DDT and concrete), aerosols, and nutrient overload (nitrogen and phosphorus from fertilisers that wash into rivers and the sea, causing algae blooms, killing fish and coral).

Crossing any of these boundaries doesn’t trigger immediate disaster. But it does mean we’ve moved from the safe zone into dangerous territory. And the nine boundaries are interrelated and interacting, in ways we don’t yet fully understand.

In 2009, the scientists found we’d already crossed three boundaries: biodiversity, climate change and nutrient overload. By the 2015 update, a fourth boundary had been crossed: land use.

And by this year’s update, only three boundaries hadn’t been crossed: ocean acidification (but only just), aerosol pollution, and stratospheric ozone depletion – where an international agreement banning CFCs is slowly reducing the ozone hole we created.

Richardson and Bai say we’re now well into the danger zone, “where we – as well as every other species – are now at risk”. “We are eating away at our own life support systems,” they say.

One thing to be said for economists is that, unlike some, they don’t try to tell scientists how to do their job. Very few economists dispute the scientists’ evidence that climate change has been caused by human activities.

It was economists who developed the best means to reduce carbon emissions – emission trading schemes – which other countries have adopted, but Australia rejected.

When our governments decide to act on the other planetary boundaries, it will be economists who work out the best way to do it.

Read more >>

We need economic growth to make us better off, right? Well, actually

For all our lives, worthies – our politicians, business people and economists – have assured us we need economic growth to make us better off. Almost everything I write assumes this to be true. But is it?

These days, there are more doubters than there used to be. Some people don’t believe that spending your life striving to own more stuff will make you happy. (Spoiler: they’re right.)

But a growing number of scientists tell us unending growth in the economy simply isn’t physically possible, and the more we keep growing the more we’ll damage the natural environment, to our great cost. Climate change is just the most glaring example of the damage we’re doing.

Historians remind us that our obsession with The Economy is relatively recent. It didn’t take hold until the middle of last century.

What we call “the economy” is all economic activity. It’s people getting up every morning, going out to earn a living, and then spending what they’ve earned. So it’s “getting and spending”, production and consumption. This is measured by gross domestic product – the value of all the goods and services produced during a period.

It was only when we started regularly measuring GDP in the mid-1950s that we began our obsession with whether it was growing and by how much. Or whether – God forfend – it was going backwards.

But these are just modern words and concepts. In truth, Australians have been preoccupied by what today we call economic growth since the day white people arrived. Their magic words were “settlement”, “progress” and “nation building”.

The recent arrivals saw a “new” nation where nothing had been done, but with huge potential for endless bush to be made to resemble the old country. They set about clearing the land, damming rivers, building houses, establishing farms and digging up minerals.

Why? To become more prosperous. They spurred themselves on with the belief they must “populate or perish” – be taken over by invading Asians.

So how do you achieve what we call economic growth? The easiest way is to grow the population. Have lots of kids and encourage (in those days, white-only) immigration. That gives you more people to work, but also more people needing to be fed, clothed, housed and entertained.

Bingo. A bigger economy. But while increasing the population makes the economy, GDP, bigger, it’s really only if the growth increases GDP per person that it can be claimed to make us better off, to have raised our material standard of living. And this doesn’t follow automatically.

The harder way to grow the economy is to increase the proportion of the population in paid employment, or to increase our investment in plant and equipment, and (well-chosen) public infrastructure. This does increase GDP per person.

But there’s another, more magical way to increase GDP per person. It’s to take the same quantity of resources – raw materials, labour and capital equipment – and use them to produce more output of goods and services than you did.

This is what people mean when they talk about increasing our “productivity”. It’s achieved, as economists keep repeating, by “working smarter, not working harder”.

How? By building a better educated and more skilled workforce, and by finding ways to make the organisation of factories and offices more efficient, but mainly by advances in technology that create better machines (and these days, computer programs) doing better tricks.

This is the bit scientists don’t get. When they hear the word “growth” they think of one thing: growth in humans’ exploitation of natural resources and all the damage we do to the environment in the process.

But that’s not what GDP measures. Economists know that most of the growth in GDP over the long term comes from increased productivity, not increased inputs of raw materials, labour and physical capital.

This means that, unless you believe there’s a limit to human ingenuity, it’s not true that continuing growth in GDP is impossible.

But when scientists say more clearly the kind of “growth” they’re referring to – growth in the use of natural resources and “ecosystem services” – it’s not possible to argue with the laws of physics.

While economists used to argue that the “limits to growth” weren’t as close at hand as some scientists had calculated, the possibility of the developing world enjoying the same profligate use of natural resources as the rich world is not credible. We expect the bottom 80 per cent to resign themselves to lives of relative poverty, while we in the top 20 per cent continue partying as though there’s no tomorrow.

So I accept that we and other rich countries will have to greatly constrain our use and abuse of the natural environment if the planet is to remain functional. A “circular economy” in which resources are so expensive that almost everything has to be repaired, reused and recycled? Sure.

But here’s the joke. It wouldn’t be the scientists who worked out how we could move to such an economy, it would be the economists.

Read more >>

All the reasons interest rates are a bad way to manage the economy

 

In outgoing Reserve Bank governor Dr Philip Lowe’s last speech, he made a striking acknowledgement: monetary policy – the manipulation of interest rates to encourage or discourage spending – “has its limitations, and its effects are felt unevenly across the community”. We should “aspire to something better”.

He’s right. So, here’s my full list of monetary policy’s limitations.

When the economy’s growing strongly, and the demand for goods and services exceeds the economy’s ability to supply them, thus pushing up prices, the need is for all of us to reduce our demand – aka our spending.

Raising interest rates is intended mainly to leave people with less money to spend on other things. But obviously, it only has this effect on people who’ve borrowed a lot, meaning its main effect is on people with big home loans.

Trouble is, only about a third of all households have a mortgage. The rest own their home outright or are renting. And some proportion of those with mortgages have had them for years and by now don’t owe much.

This is what Lowe means by saying monetary policy’s effects are felt unevenly across the community. Younger people with super-sized mortgages really feel it, while the rest of us don’t feel much.

So, using interest rates to discourage spending can be seen as unfair: it picks on only those who happen to have big mortgages.

But the unfairness is multiplied because monetary policy’s selectivity limits its effectiveness. To achieve the desired slowdown in total spending, the 25 per cent or so of households with big mortgages have to be hit all the harder.

But that’s just the most obvious of monetary policy’s “limitations”. Another is its effect not on the people who borrow from banks, but on those who lend to them, aka depositors.

These people – many of whom are retired and depending on interest earnings for their livelihood – should be getting a steady income. Instead, their income bounces around, depending on whether the central bank is trying to encourage or discourage spending.

How is this fair to depositors? And remember this: in principle, when the central bank obliges the banks to increase mortgage interest rates by, say, 4 percentage points, that increase should be passed through to the interest rates on deposits.

In practice, however, this rarely happens in full. With just four big banks dominating the mortgage market, their pricing power lets them widen their interest rate margin between what they pay for deposits and what they charge borrowers.

So, part of the pain the central bank imposes on people with mortgages ends up fattening the pay of bank executives and the dividends of bank shareholders. How is this fair?

Remember the failure of the Silicon Valley Bank in America? It had a lot of money parked in US government bonds, but was wrong-footed by the US Federal Reserve’s sudden move to jack up interest rates.

Central banks are responsible for ensuring the stability of the banking system. But their use of interest rates to manage demand can add to banking instability in a way that other means of influencing demand wouldn’t.

It hasn’t been a problem in Australia, however, because our much more oligopolised banking system means our banks are hugely profitable and so less likely to fall over.

On the other hand, whereas in the US and elsewhere home loans have an interest rate that’s fixed over the long life of the loan, most of our home loans have rates that can be changed as often as the bank thinks necessarily.

It’s this that makes monetary policy more immediately effective – and painful – in Australia than in other economies. A reason we should start the move away from monetary policy.

Lowe is right to say that monetary policy isn’t primarily to blame for the high cost of housing. It is, as he says, the result of the way we’ve encouraged our politicians to bias the system in favour of those who already own a home, to the disadvantage of those who’d like to own one.

Even so, watching all those young people signing up for massive loans while interest rates were at unprecedented lows during the pandemic made me wonder if the Reserve’s moving of interest rates up and down doesn’t create a FOMO effect: when rates are low, first-home buyers load up with debt – and bid up house prices – for “fear of missing out” when rates go back up.

As Lowe acknowledged after his speech, the continued use of monetary policy as pretty much our only means of slowing demand is threatened by another, quite different development: the slow disappearance of the world long-term real interest rate, which has had the lasting effect of lowering world nominal interest rates by about 3 percentage points, and so bringing them much closer to the “zero lower bound”, known to normal people as just zero.

This means interest rates can still be raised to discourage borrowing and spending but – as we’ve witnessed over the past decade – often can’t be cut very far to encourage borrowing and spending.

At the time of the global financial crisis in 2008, and again during the pandemic, the US Federal Reserve and the other big central banks sought to overcome this barrier by resorting to unconventional “quantitative easing” (QE) – mainly, buying shed loads of second-hand government bonds to force down longer-term interest rates.

One of the main effects of this has been to lower the country’s exchange rate at the expense of its trading partners. Which is why, once the Fed starts doing it, other central banks feel they have to do it too, in self-defence.

But while “QE” seems quite effective in raising the prices of assets such as shares, it’s not very effective in boosting demand for goods and services and thus encouraging economic growth.

I think history will judge QE to have been a bad idea. It will be another reason we’ll need to become much less reliant on interest rates to manage the economy.

Read more >>

Jury still out on how much hip pocket pain still coming our way

It’s not yet clear whether the Reserve Bank’s efforts to limit inflation will end up pushing the economy into recession. But it is clear that workers and their households will continue having to pay the price for problems they didn’t cause.

Prime Minister Anthony Albanese didn’t cause them either. But he and his government are likely to cop much voter anger should the squeeze on households’ incomes reach the point where many workers lose their jobs.

And he’ll have contributed to his fate should he continue with his apparent intention to leave the stage-three income tax cuts in their present, grossly unfair form.

The good news is that we’re due to get huge hip pocket relief via the tax cuts due next July. The bad news is that the savings will be small for most workers, but huge – $170 a week – for high-income earners who’ve suffered little from the squeeze on living costs.

Should Albanese fail to rejig the tax cuts to make them fairer, you can bet Peter Dutton will be the first to point this out. But he’ll need to be quick to beat the Greens to saying it.

Those possibilities are for next year, however. What we learnt this week is how the economy fared over the three months to the end of June. The Australian Bureau of Statistics’ “national accounts” show it continuing just to limp along.

Real gross domestic product – the value of the nation’s production of goods and services – grew by only 0.4 per cent – the same as it grew in the previous, March quarter. Looking back, this means annual growth slowed from 2.4 per cent to 2.1 per cent.

If you know that annual growth usually averages about 2.5 per cent, that doesn’t sound too bad. But if you take a more up-to-date view, the economy’s been growing at an annualised (made annual) rate of about 1.6 per cent for the past six months. That’s just limping along.

And it’s not as good as it looks. More than all the 0.4 per cent growth in GDP during the June quarter was explained by the 0.7 per cent growth in the population as immigration recovers.

So when you allow for population growth, you find that GDP per person actually fell by 0.3 per cent. The same was true in the previous quarter – hence all the people saying we’re suffering a “per capita recession”.

As my colleague Shane Wright so aptly puts it, the economic pie is still growing but, with more people to share it, the slices are thinner.

It’s possible that continuing population growth will stop GDP from actually contracting, helping conceal from the headline writers how tough so many households are faring.

But the media’s notion that we’re not in recession unless GDP falls for two quarters in a row has always been silly. What makes recessions such terrible things is not what happens to GDP, but what happens to workers’ jobs.

It’s when unemployment starts shooting up – because workers are being laid off and because young people finishing their education can’t find their first proper job – that you know you’re in recession.

In the month of July, the rate of unemployment ticked up from 3.5 per cent to 3.7 per cent, leaving an extra 35,000 people out of a job. If we see a lot more of that, there will be no doubt we’re in recession.

But why has the economy’s growth become so weak? Because households account for about half the total spending in the economy, and they’ve slashed how much they spend.

Although consumer spending grew by 0.8 per cent in the September quarter of last year, in each of the following two quarters it grew by just 0.3 per cent, and in the June quarter it slowed to a mere 0.1 per cent.

Households’ disposable (after-tax) income rose by 1.1 per during the latest quarter but, after allowing for inflation, it actually fell by 0.2 per cent – by no means the first quarter it’s done so.

What’s more, it fell even though more people were working more hours than ever before. People worked 6.8 per cent more hours than a year earlier.

So why did real disposable income fall? Because consumer prices rose faster than wage rates did. Over the year to June, prices rose by 6 per cent, whereas wage rates rose by 3.6 per cent.

Understandably, people make a big fuss over the way households with big mortgages have been squeezed by the huge rise in interest rates. But they say a lot less about the way those same households plus the far greater number of working households without mortgages have been squeezed a second way: by their wage rates failing to rise in line with prices.​

This is why I say the nation’s households are paying the price for fixing an inflation problem they didn’t cause. It’s the nation’s businesses that put up their prices by a lot more than they’ve been prepared to raise their wage rates.

Businesses have acted to protect their profits and – in more than a few cases – actually increase their rate of profitability. In the process, they risk maiming the golden geese (aka customers) that lay the golden eggs they so greatly covet.

If you think that’s unfair, you’re right – it is. But that’s the way governments and central banks have long gone about controlling inflation once it’s got away. It was easier for them to justify in the olden days – late last century – when it was often the unions that caused the problem by extracting excessive wage rises.

But those days are long gone. These days, evidence is accumulating that the underlying problem is the increased pricing power so many of our big businesses have acquired as they’ve been allowed to take over their competitors and prevent new businesses from entering their industry.

The name Qantas springs to mind for some reason, but I’m sure I could think of others.

Read more >>

NSW Treasury's new realism: productivity won't be speeding up

Have you noticed how people keep banging on about “productivity” these days? That’s because it’s the secret sauce of economics, the bit that comes closest to giving us a free lunch. But also because we haven’t actually been getting much of it lately.

Unfortunately, that’s made productivity a happy hunting ground for bulldust propositions. So let’s spell out exactly what productivity is.

A business – or a whole economy – improves its productivity when it finds ways to produce more outputs of goods and services with the same inputs of raw materials, labour and physical capital.

Sounds a great idea, but how is it possible? Short answer: advances in technology. Workers become more productive when they’re given tools and machines to work with. Many improvements in technology are designed to make workers more productive.

Better education and training make workers more productive by increasing their “human capital”. Even finding better ways to organise factories and offices can improve productivity. So can be teaching bosses better ways to jolly along their troops.

In my writing about the topic, I always focus on the simplest and least inaccurate way of measuring productivity. The productivity of labour is just output per worker or, better, output per hour worked.

Another approach would be to measure the productivity of the other main “factor of production”, capital equipment and constructions: output per unit of capital employed.

But economists often prefer to focus on “total-factor productivity” (or “multifactor productivity” as the statisticians prefer to call it): the growth in output (gross domestic product) that can’t be explained by increased use of labour and capital.

Economists have discovered that most of the improvement in people’s material standard of living over the years and centuries has come from improvement in total-factor productivity. This is why economists seem so obsessed by it. Keep productivity improving and we get wealthier.

But, as you see, total-factor productivity can’t be measured directly. It’s measured as a residual – what’s left when you take GDP and subtract two different things – which increases the chance your measurement is wrong.

And the truth is, economists don’t know as much about what causes productivity improvement as they ought to. That’s why they’ve spent the past decade debating the reasons that productivity growth has slowed significantly in all the advanced economies, not just Australia.

Theories abound, but there’s no agreement. And while we’re hearing plenty of tub-thumping sermons from business people (and central bankers) with their own axes to grind, there’s no agreement on what we should be doing apart from blaming the government and demanding it do something.

But last year, Professor Thomas Philippon of New York University wrote a working paper that offered a quite different explanation for the weak productivity growth we’ve been experiencing.

Conventional economic theory assumes that total-factor productivity grows “exponentially”, but Philippon has examined America’s productivity figures since 1947 – and done the same for a large group of other advanced economies – and found the growth has merely been “linear”.

Huh? Try this. If you have $100 growing 2 per cent each year, that’s exponential. If instead it just grows by $2 a year, that’s linear. Exponential growth is a fixed percentage rate; linear growth is a fixed absolute amount. The first $2 is 2 per cent of $100, but over the years the percentage rate of growth slowly declines.

So Philippon is saying we’ve been expecting productivity to grow at a much faster percentage rate than we should have been. Because its growth is “additive” rather than “multiplicative”, its annual percentage growth is declining.

The assumption that productivity improvement is exponential implies that innovation today makes further discoveries easier in the future. Philippon, however, finds that new ideas add to our stock of knowledge, but they don’t multiply it.

In the NSW Treasury’s new research paper, Trends in productivity: What should we expect, Keaton Jenner and Angus Wheeler have replicated Philippon’s exercise for Australia, getting similar results.

Whereas the standard exponential model implies that total-factor productivity should have grown at the annual rate of 1.7 per cent between 1983 and 2019, they find this significantly overshoots actual productivity growth.

But the new, additive model implies that productivity increases by 0.024 points per year, with an annual growth rate that tapers down from 1.25 per cent in 1984 to 0.9 per cent in 2019.

So, Philippon’s additive model yields what would have been a much more accurate – though still slightly optimistic – forecast.

This suggests that, without some major new “general-purpose” technological advance (such as the spread of electricity, or the internal-combustion engine), the model predicts that total-factor productivity growth will slowly fall to zero per cent.

But this doesn’t mean living standards wouldn’t continue to improve. Because living standards are powered by the productivity of labour, the authors find, they would grow by increasingly larger absolute amounts, but not at a steady, exponential rate of growth.

In the NSW government’s intergenerational report in 2021, productivity projections were based on the historical 30-year average exponential rate of 1.2 per cent a year. Other assumptions meant that real gross state product was projected to grow at an average rate of 2.2 per cent a year out to 2041.

The authors repeat this exercise using an additive productivity model and find that annual growth in labour productivity declines from 1 per cent to 0.8 per cent over the 20 years to 2041. This means an average annual rate of growth in real gross state product of 1.9 per cent – 0.3 percentage points lower that projected in the 2021 report.

The authors point out that, if realised, the NSW economy would be about 7 percentage points smaller in 2041 than was projected in the report two years’ ago. This, in turn, would have “material implications” for the government’s revenue base and budget balance, assuming no offsetting reduction in government spending.

It will be interesting to see if Victoria and the other state governments recalibrate their projections using this new, more pessimistic – but more realistic – view of the future.

Read more >>

Another rise in interest rates is enough already

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

How much slower would you like it to get?

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

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

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

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

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

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

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

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

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

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

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

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

Read more >>

Wellbeing? Measure what matters, then start fixing it

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Read more >>

Maybe Lowe should stay on as governor to clean up any spilt milk

I’ve never liked making free with the R-word until it’s an undeniable reality. Too many journalists refuse to recognise that if enough people in positions of influence predict bad things enough times, their predictions have a tendency to become reality.

But I confess I’m starting to worry that Reserve Bank governor Dr Philip Lowe – a man who, until now, I’ve always regarded as having steady judgment – is pressing harder on the interest-rate brakes than he needs to. And I don’t think I’m the only economy-watcher who shares that fear.

He seems to be seizing on any argument that says he should give the thumbscrews another turn, while ignoring all the arguments that say he’s already done enough. The Fair Work Commission has awarded the people whose wages constitute the bottom 10th of the national wage bill a 5.75 per cent pay rise. Oh, no! Give it another turn.

Employment grew by 76,000 in May and the unemployment rate went down a fraction. Oh, no! Give it another turn.

One of the rules of using interest rates to suppress demand is that they work with “long and variable lags” so that, if you keep tightening until it’s clear you’ve done enough, you’ve already done too much and will crash the economy. But Lowe seems to have forgotten this.

Another thing he seems to have forgotten is that, in times past, we’ve needed a big increase in interest rates to slow a booming economy because the boom has resulted in real wages growing so strongly.

Not this time. This time an unusual feature of the boom has been that real wages have been falling for several years. Do you realise that real labour costs per unit of production are now 6 per cent lower than they were at the end of 2019?

What’s been (conveniently) forgotten is that, in the early days of the pandemic, when we imagined we were in for a severe recession, employers were quick to demand a wage freeze, to which workers readily acquiesced.

Turned out that a couple of lockdowns don’t equal a recession, and employers did fine. But there was no suggestion of a catch-up for the wage freeze that wasn’t needed. Remember this next time you see Lowe banging on about the worrying rise in nominal labour costs per unit.

If Lowe knew more about how wages are fixed in the real world, rather than in economics textbooks, he’d have noticed that the union movement’s failure to talk about the need for a wage catch-up was a sign of its diminished bargaining power.

(He’d also be more conscious that the conventional economic model’s implicit assumption – that the parties to every transaction are of roughly equal bargaining power – doesn’t hold between an employer and an employee. Nor between a big business and a small business, for that matter.)

Then there’s Lowe’s invention of a new doctrine (one previously exclusive to bull-dusting employer groups) that workers need to produce more if they want their wages merely to keep up with inflation.

Lowe professes to be terribly worried about a fall in the productivity of labour in recent quarters but, as The Conversation website’s Peter Martin has reminded us, falling productivity (output per hour worked) is exactly what you’d expect to see at a time when falling unemployment is returning us to full employment.

Employers have preferred to hire more workers rather than buy more labour-saving machines. And, as the econocrats have pointed out, they’re having to hire more of the kinds of workers they usually prefer not to hire – the young, the old and the long-term unemployed.

That is, they’ve had to start hiring the less-productive. This is a bad thing, is it?

One reason I’m shocked by Lowe’s newly invented line that, absent productivity improvement, all wage growth above 2.5 per cent is inflationary, is that I was around in the 1970s when wage growth really was excessive and inflationary. It was to be condemned then; but anyone saying it now has moved the goal posts.

It was then that Treasury made so much fuss about labour costs per unit that the Bureau of Statistics began publishing the figures every quarter – the ones Lowe has been leaning on so heavily.

But when the Australia Institute think tank copied the method used by the European Central Bank (and now by the Organisation for Economic Co-operation and Development) to calculate profits per unit, the econocrats wrote learned treatises saying its method was “flawed”. Apparently, sauce for the wages goose is not sauce for the profits gander.

Speaking of flaws, the flaw in Lowe’s new-found argument that wage rises exceeding 2.5 per cent, but less than the rise in prices, are inflationary ought to be obvious to anyone not blinded by pro-business bias. It doesn’t add to the inflation rate, but it does add to the time it takes for the inflation rate to fall back.

So, what Lowe’s on about is the speed at which inflation is returning to (the now unrealistically low) target range of 2 to 3 per cent. And he’s in such a tearing hurry he’s prepared to risk causing a recession.

Why? Well, what I wonder is whether Lowe’s expectation that his term as governor won’t be renewed in September – so a new governor can make the changes the Reserve Bank review has recommended – is affecting his judgment.

There’s a concept in economics called “revealed preference” which says: judge people not by what they say, but what they do. Lowe says he’s aiming for the “narrow path” to low inflation without a recession.

But what he seems to be aiming for is low inflation come hell or high water. I wonder if he’s decided he prefers not to be remembered as the governor who let inflation get out of control, but left without fixing it.

If, to avoid that fate, he has to be remembered as the guy who plunged the economy into a recession no one thought was needed, then them’s the breaks.

The sad truth about independent central banks is that, if they really stuff up, it’s the elected government that gets blamed. Since there’s no voting for who’s to be governor, there’s no other way voters can register their disaffection.

So, if Lowe continues finding excuses to tighten the monetary screws, don’t be surprised if the Albanese government gets ever less muted in its criticism.

But if I were Treasurer Jim Chalmers, I’d consider postponing the reform of the Reserve’s procedures and extending Lowe’s term, so his mind could be fully focused on achieving the soft landing – or be around to share the blame if he crashes the plane. And help mop up the debris if he fails. This may also stop him acting so uncharacteristically.

Read more >>

Economy close to stalling, as Reserve hits the brakes yet again

It’s been a puzzling week, as we learnt the economy had slowed almost to stalling speed, just a day after the Reserve Bank raised interest rates for the 12th time, and warned there may be more.

According to the Australian Bureau of Statistics’ “national accounts”, real gross domestic product – the economy’s production of goods and services – grew by just 0.2 per cent over the three months to the end of March.

That took growth over the year to March down to 2.3 per cent, which sounds better than it is because the economy has slowed so rapidly. If it continued growing by 0.2 per cent a quarter, that would be annual growth of 0.8 per cent.

And the resumption of immigration means the population is now growing faster than the economy. Allow for population growth and GDP per person actually fell by 0.2 per cent. Over the year to March, it grew by only 0.3 per cent.

While a growing population is good for businesses – they have more potential customers – to everyone else, economic growth has been sold to us as raising our material standard of living. Not much chance of that if GDP per person is falling.

The Reserve Bank has been trying to slow the economy down because demand for goods and services has been growing faster than the economy’s ability to supply them, thus allowing businesses to increase their prices.

With additional help from the rising prices of imported goods and services, the rate of inflation has shot up. It’s started falling back from its peak of 7.8 per cent at the end of last year, but is still way above the Reserve’s 2 per cent to 3 per cent target range.

The Reserve’s been raising the interest rates paid by the third of households with mortgages, to reduce their ability to spend on other things. But, at this stage, probably the biggest dampener on consumer spending is coming from the failure of wages to keep up with rising prices.

“Demand” means spending, so if households find it harder to spend on goods and services, that makes it harder for businesses to raise their prices, thus bringing the inflation rate back down.

And remember that the full effect of all the interest rate rises we’ve seen is still to be felt. The pain will increase over the rest of this year.

But if I were Reserve Bank governor Dr Philip Lowe, I wouldn’t be too worried that the plan wasn’t working. The biggest single factor driving GDP is consumer spending, which accounts for more than half of all spending. In the June quarter last year, it grew by 2.2 per cent.

The following quarter its growth fell to 0.8 per cent, then 0.3 per cent, and now 0.2 per cent. Wow. I think the squeeze is working.

Although more people have been working more hours, real household disposable income fell by 0.3 per cent in the quarter, and by 4 per cent over the year to March.

It was hit by the failure of wages to rise in line with prices, by the doubling in households’ interest payments, and by the bigger bite that income tax took out of pay rises, caused by bracket creep.

How did households manage to keep their consumption spending growing despite their falling real income? By cutting the proportion of their income that they were saving from more than 11 per cent in March quarter last year to less than 4 per cent this March quarter – the lowest it’s been in about 15 years.

Household investment spending on newly built homes and alterations fell by 1.2 per cent, its sixth fall in seven quarters.

One bright spot was growth in business spending during the quarter of 2.9 per cent, led by spending on machinery and equipment, and non-dwelling construction – particularly on renewables and electricity infrastructure.

Unfortunately, much of the machinery investment was on imported equipment that had been delayed by the pandemic, so it’s not a sign of continuing strength. The volume of spending on imports was a super-strong 3.2 per cent, but imports subtract from GDP, of course.

Treasurer Jim Chalmers always blames the economy’s slowdown on higher interest rates (blame the Reserve, not me), high inflation (not me either) and “a slowing global economy” (blame the rest of the world).

A slowing global economy? Yes, of course. Everyone’s heard about that. Trouble is, the main way the rest of the world affects us is by buying – or not buying – our exports. And the volume of our exports grew by 1.8 per cent in the March quarter, and 10.8 per cent over the year to March. That’s because our miners have done so well (and our fossil-fuel-using households and businesses so badly) out of the higher world coal and gas prices caused by the Ukraine war.

Even so, this quarter’s growth in export volumes of 1.8 per cent has been swamped by the 3.2 per cent growth in import volumes, meaning that “net exports” – exports minus imports – subtracted 0.2 percentage points from the overall growth in real GDP during the quarter.

After Lowe’s decision on Tuesday to raise rates yet again, Chalmers wasn’t mincing his words. “I do expect that there will be a lot of Australians who find this decision difficult to understand and difficult to cop – ordinary working Australians are already bearing the brunt of these interest rate rises, they shouldn’t bear the blame too,” he said.

“The Reserve Bank’s job is to quash inflation without crashing the economy, and they will have a lot of time and opportunities to explain and defend the decision that they’ve taken today.”

Lowe has said repeatedly that he’s seeking the “narrow path” where “inflation returns to target within a reasonable timeframe, while the economy continues to grow, and we hold on to as many of the gains in the labour market [our return to full employment] as we can”.

After seeing the next day’s GDP figures, Paul Bloxham of HSBC bank observed that the narrow path “is looking extremely narrow indeed”. True.

Read more >>

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.

Read more >>

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.

Read more >>

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.

Read more >>

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.

Read more >>

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.

Read more >>

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.

Read more >>

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.

Read more >>