How to lift our schools’ performance

We’re at it again. Every time education or healthcare pops up in the news, it’s almost always people arguing about money and how much of it they’re getting. Rarely is it people discussing how the billions we’re already spending could be used more effectively.

There’s nothing the media love more than a fight. And when it comes to government spending, there’s never a shortage of interest groups demanding more or predicting death and destruction if their funding’s cut.

Now “Gonski” is back in the news, but it’s people still arguing the toss about David Gonski's first report on needs-based funding, not Gonski 2.0 on how we can improve a school system that’s failing far too many of its students.

Inevitably, the latest fight is sectarian. The Catholics are trying to extract special deals from both Labor and the Coalition before the election, while the largely Protestant “independent” sector is threatening to arc up if the Catholics succeed.

Hope Jesus is pleased with the example you’re setting your students, guys.

The Melbourne-based Grattan Institute takes pride in focusing on more substantive policy issues. And it got through a public discussion of Gonski 2.0 in Sydney last week without once mentioning funding.

Gonski’s second bite at the education cherry confirmed that, since 2000, Australian student outcomes have declined in key areas such as reading, science and maths. There’s a wide gap between our best and worst performers.

It’s a gap that won’t be magically removed by needs-based funding. So what does Gonski suggest?

The first of his three priorities is to “deliver at least one year’s growth in learning for every student every year”. Our achievement gap shows that many of our kids get through a year without learning all the curriculum assumes they have.

Gonski says we still have a 20th century industrial-style model of schooling where students are grouped by grade and age, learn or don’t learnt what they’re supposed to, then move in lockstep to the next grade.

At the end of the half-year or year they’re tested to see how much they’ve learnt, mainly so they can be ranked according to how well they performed in the competition.

Gonski wants to move to a model that focuses on measuring “growth” – the progress each individual student is making along a defined “learning progression”, which is an empirically determined list of the sequence in which most students learn the steps to acquiring, say, literacy or numeracy.

Teachers make regular assessments of each individual’s progress, so they know what the kid’s ready to learn next. This helps prevent the slower students falling hopelessly behind, but also makes sure the brighter students are stretched.

These regular assessments are diagnostic rather than how you’re going in the comp. Students are applauded for their growth, not for coming top. As Paul Cahill, of the Catholic Schools system, said to the Sydney gathering, we need more growth in learning and less ranking and sorting.

Just as well, because all those diagnostic assessments will be time-consuming. Gonski says education authorities should develop an online and on-demand student learning assessment tool for teachers and also “limit the burden of non-core activities such as administrative tasks”.

This move to “targeted teaching” is being practiced in some schools and is endorsed by much research. It just needs to be used much more widely.

Gonski’s second priority is to “equip every child to be a creative, connected and engaged learner in a rapidly changing world”.

“As routine manual and administrative activities are increasingly automated, more jobs will require a higher level of skill, and more school-leavers will need skills that are not easily replicated by machines, such as problem-solving, interactive and social skills, and critical and creative thinking,” his report says.

People call these “soft skills” or “21st century skills”, but the educationists’ term is “general capabilities”. There’s wide agreement that these things warrant greater attention, and has been for a decade. What’s missing is the will to get on with it.

But some worry that more emphasis on soft skills means dumbing down the syllabus. More touchy-feely means less knowledge of facts and concepts.

At last week’s gathering, however, Leslie Loble, of the NSW Education Department, insisted there need be no conflict. General capabilities and hard knowledge must always go together; you gain your general capabilities while learning the traditional subjects.

Grattan’s highly influential school education expert, Dr Peter Goss, noted that Gonski 2.0’s greatest strength – it wasn’t urging the Feds to impose its priorities on the states and territories – is also its great weakness. As I’d put it, now we have to wait for Brown’s cows to get their acts together.

The longer it takes, the more of our young people get off to a bad start in life.

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Why inequality is bad for growth

As any economist will tell you, it's all very well to care about "fairness" – whatever that is – but efforts to reduce the inequality of incomes in the economy usually come at the cost of lower economic efficiency.

So if you insist in reducing inequality you'll have to settle for slower economic growth. Much better to put up with inequality and enjoy a faster rise in our average material standard of living.

For decades that's been the economics profession's conventional wisdom on the question of inequality. But, next time some economist assures you of all that, it will be safe to assume they're not keeping up with the research.

Either that or they prefer sticking to their long-standing political preferences rather than changing their views in line with the empirical evidence.

That's the point: the economists' age-old assumption that "equity" (fairness) and efficiency are in conflict – that more of one means less of the other – fits with their theories, but is now being contradicted by empirical studies, many of them coming from such authoritative institutions as the Organisation for Economic Co-operation and Development and the International Monetary Fund.

Last year staff at the fund published a study finding that income inequality between households, as shown by an overall measure such as the "Gini coefficient" – which is zero when everyone has the same income, rising to 1 when one person has all the income – adversely affects economic growth.

Last week the fund's staff published a new study building on this analysis by looking at the experience of people in different positions at the bottom, middle and top of the distribution of incomes, in almost 100 advanced and developing countries over the 22 years to 2012.

The new study confirms that a high Gini coefficient for net income (income earned in the market, less taxes and plus government cash benefits) is associated with lower growth in real gross domestic product over the medium term.

But it also finds an inverse relationship between the size of the income share going to the rich (defined here as the top 20 per cent of households) and the speed at which the economy grows.

If the income share of the top 20 per cent increases by 1 percentage point, GDP growth is 0.08 percentage points lower in the following five years, suggesting that the benefits do not "trickle down" to the rest of us.

By contrast, if the income share going to the poor (the bottom 20 per cent) increases by 1 percentage point, GDP growth is 0.38 percentage points higher in the following five years.

This positive relationship between shares of disposable income and higher growth continues to hold for the second and third quintiles (blocks of 20 per cent) which, following American practice, the authors refer to as the middle class. (This must mean that people in the second top quintile are the upper middle.)

The paper's authors quote other studies to help explain why higher income shares for the poor and middle class are growth-enhancing.

They note research showing that higher inequality lowers growth by depriving lower-income households of the ability to stay healthy and accumulate physical capital (a home, a car, a heating system) and human capital (education and training).

"For instance, it can lead to underinvestment in education as poor children end up in lower-quality schools and are less able to go on to college," they say. "As a result, labour productivity could be lower than it would have been in a more equitable world."

Other research finds that countries with higher levels of income inequality tend to have lower levels of mobility between generations, with parents' earnings being a more important determinant of children's earnings.

As well, increasing concentration of income at the top could reduce total demand (spending), and so undermine growth, because the wealthy spend a lower fraction of their incomes than middle and lower-income groups do.

"Extreme inequality may damage trust and social cohesion and thus is also associated with conflicts, which discourage investment," the authors say.

Inequality affects the economics of conflict as it may intensify the grievances felt by certain groups or reduce the opportunity cost of initiating and joining a violent conflict. If you're poor you've got less to lose.

So what should governments that want faster economic growth be doing to promote it?

"Redistribution through the tax and transfer [welfare benefits] system is found to be positively related to growth for most countries, and is negatively related to growth only for the most strongly redistributive countries," they say.

"This suggests that the effect of stability could potentially outweigh any negative effects on growth through a dampening of incentives."

The redistributive role of the budget "could be reinforced by greater reliance on wealth and property taxes, more progressive income taxation, removing opportunities for tax avoidance and evasion, and better targeting of social benefits while also minimising efficiency costs in terms of incentives to work and save".

"In addition, reducing tax expenditures [tax breaks] that benefit high-income groups most and removing tax relief – such as reduced taxation of capital gains, stock options and carried interest – would increase equity and allow a growth-enhancing cut in marginal labour income tax rates in some countries."

Then there's the reform of the labour market. "Appropriately set minimum wages, spending on well-designed active labour market policies aimed at supporting job search and skill matching can be important."

"Moreover, policies that reduce labour market dualism, such as gaps in employment protection between permanent and temporary workers – especially young workers and immigrants – can help to reduce inequality, while fostering greater market flexibility.

"Labour market rules that are very weak or programs that are non-existent can leave problems of poor information, unequal power and inadequate risk management untreated, penalising the poor and the middle class,' they say.

Sounds like our economists have a lot to learn.

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Widening income gap slows economic growth

One of the most significant developments in applied economics in recent times is something we've heard little about in Australia, where we seem to be living in our own little cocoon, oblivious to advances in the rest of the world.

For decades, economic policy in Australia - and most other developed countries - has been based on the assumption that there's a trade-off between economic efficiency and fairness (or "equity" as economists prefer to call it).

If governments try to make the distribution of income between households less unequal by, say, using taxes and government spending to redistribute income from rich to poor, or by setting a reasonable minimum wage, it's long been believed, this will make the economy less efficient and so cause it to grow more slowly.

On the other hand, if governments don't do as much to redistribute income away from high-income earners, this will provide stronger incentives for people to work harder, invest and accept risk in the pursuit of greater profits.

This, in turn, will cause the economy to grow faster, leaving us all better off. What's more, the rich have a higher propensity to save, and greater saving will finance additional productive investment.

So, sorry about that, but we have to go easy on high-income earners because this makes the economy work better.

This belief that fairness reduces growth but unfairness fosters it lies behind many of the tax "reforms" we've seen over the years.

The moves to cut the top income tax rate from 67 per cent to 47 per cent, to tax capital gains at half the rate applying to other income, to end the double taxation of dividends and to use introduction of the goods and services tax to increase indirect taxation and cut income tax, are all motivated by the belief this would be better for the economy.

Trouble is, there's been surprisingly little empirical evidence to support this theory - a theory, you'll be surprised to hear, rich people really like (just ask the Business Council).

In recent years, however, the academic tide has turned and researchers are finding increasing evidence that inequality may actually be bad for economic growth. The tide has turned so far it's reached the international economic agencies (though not our econocrats).

Early this year, three researchers at the International Monetary Fund, Jonathan Ostry, Andrew Berg, and Charalambos Tsangarides, published a paper on Redistribution, Inequality and Growth, which found that lower inequality was reliably correlated with faster and longer-lasting economic growth.

What's more, they found that redistribution - the thing economists have long assumed would dampen incentives - seems to have no adverse effect on growth, except perhaps in extreme cases.

"We should be careful not to assume that there is a big trade-off between redistribution and growth. The best available macro-economic data do not support that conclusion," they found.

And now, this week, the Organisation for Economic Co-operation and Development has published a paper by Federico Cingano, Trends in Income Inequality and its Impact on Economic Growth, that comes to similar conclusions.

In most OECD countries, the gap between rich and poor is at its highest in 30 years. In the 1980s, the top 10 per cent of households earnt seven times what the poorest 10 per cent earnt. Today it's 9 1/2 times. (In Oz it's 8 1/2 times.)

Cingano says that doing something about this trend has moved to the top of the policy agenda in many countries.

"This partly due to worries that a persistently unbalanced sharing of the growth dividend will result in social resentment, fuelling populist and protectionist sentiments and leading to political instability," he says.

But another, growing reason for policy-makers' interest in inequality is its possible effect in reducing economic growth and slowing the recovery from the Great Recession.

His econometric comparisons of the performance of OECD countries over the past 30 years confirm earlier findings that increasing income inequality has an adverse effect on later economic growth. In New Zealand, for instance, its total growth over the 20 years to 2010 would have been more than 10 per cent greater had its income disparity not widened as much as it did over the 20 years to 2005.

For both the United States and Britain, their cumulative growth would have been more than 20 per cent greater.

You could argue that just because inequality reduces the rate of economic growth, this doesn't mean government measures to redistribute income will make things better. Those measures could, by reducing economic incentives, make their own contribution to reducing growth.

You could argue it, but you'd get no support from Cingano's analysis of the evidence. "These results suggest that inequality in disposable incomes is bad for growth, and that redistribution is, at worst, neutral to growth," he finds.

But get this: he found that what does most to inhibit growth is an increasing gap between low-income households (the bottom 40 per cent) and the rest of the population.

"In contrast, no evidence is found that those with high incomes pulling away from the rest of the population harm growth," he says.

So the rich attract most envy and resentment, but they're not what inhibits growth. What is it about inequality in the bottom half of the distribution that leads to weaker economic growth in later years?

Cingano finds support for the "human capital accumulation theory", suggesting that lower relative increases in the incomes of families in the bottom half make it harder for them to invest in the education and training that increases the value of their labour and the size of their contribution to growth.

But I've got an idea. Why not get a businessman, say, David Gonski, to propose ways of making sure the socially and economically disadvantaged get a good education?

And why don't we hugely increase university fees? That's bound to make us grow a lot faster.

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How economists changed their tune on minimum wages

When the Fair Work Commission announced a 3 per cent increase in the national minimum wage to more than $640 a week - or almost $16.90 an hour - from last week, employers hinted it would lead to fewer people getting jobs and maybe some people losing theirs.

And to many who've studied economics - even many professional economists - that seems likely. If the government is pushing the minimum wage above the level that would be set by the market - the "market-clearing wage" - then employers will be less willing to employ people at that rate.

That's because market forces set the market rate at an unskilled worker's "marginal product" - the value to the employer of the worker's labour.

Almost common sense, really. Except that such a conclusion is based on a host of assumptions, many of which rarely hold in the real world. And over the past 20 years, academic economists have done many empirical studies showing that's not how minimum wages work in practice. They've also developed more sophisticated theories that better fit the empirical facts. It's all explained in the June issue of the ACTU's Economic Bulletin.

As a result, there's been a big swing in academic thinking on the question of the minimum wage. Last year, researchers at the University of Chicago asked a panel of economists from top US universities whether they agreed with the statement that "the distortionary costs of raising the federal minimum wage to $US9 per hour and indexing it to inflation are sufficiently small compared with the benefits to low-skilled workers who can find employment that this would be a desirable policy".

Fully 62 per cent agreed and 16 per cent disagreed, leaving 22 per cent uncertain.

Earlier this year, more than 600 US economists - including seven Nobel laureates - signed an open letter to Congress advocating a $US10.10 minimum wage. They said that, because of important developments in the academic literature, "the weight of evidence now [shows] that increases in the minimum wage have had little or no negative effect on the employment of minimum-wage workers".

The first such study, published by David Card and Alan Krueger in 1994, compared fast food employment in New Jersey and Pennsylvania after one state raised its minimum wage and the other didn't. They did not find a significant effect on employment.

Since then, many similar US "natural experiments" have been studied and have reached similar findings. In Britain, the Low Pay Commission has commissioned more than 130 pieces of research, with the great majority finding that minimum wages boost workers' pay but don't harm employment.

There's been less research in Australia, but one study by economists at the Australian National University, Alison Booth and Pamela Katic, suggests that the facts in Australia seem to fit the "dynamic monopsony" model of wage-fixing.

Under the simple textbook, "perfect competition" model of the market for labour, individual firms face a horizontal supply curve: each firm is so small that its demand for labour has no effect on the price of labour. It can buy as much labour as it needs at an unchanged price.

In the dynamic monopsony model, however, each firm faces an upward-sloping labour supply curve. This is because more realistic assumptions recognise the existence of "imperfections" or, more specifically, "frictions".

Such as? Workers may not have perfect information about all the alternative jobs they could take and this could make them cautious about moving. Searching for a job may involve costs in time or money. Workers and jobs may be mismatched geographically, so changing jobs may involve greater transport costs. Workers - being humans rather than inanimate commodities - may not have identical preferences about the jobs available.

In other words, there are practical reasons why it takes a lot for a worker to want to leave their job.

These frictions, or "transaction costs", are assumed away in the simple model. But their existence can result in employers having market power, which they can take advantage of to pay workers less than the value of what they produce (their marginal product).
Economists call such power "monopsony" power. Just as a monopolist is a single seller, so a monopsonist is a single buyer. But don't take that word too literally. An employer with monopsony power doesn't need to be a monopolist in the market for its product (the "product" market), nor the sole buyer of labour in the region or the industry.
"A single employer in a market with many employers can have monopsonistic power if workers bear costs of job search," the article continues. In other words, it possesses a degree of monopsony power.

The point is, if a firm is facing an upward-sloping labour supply curve and wants to hire more workers, it may need to pay a higher wage than it is paying its existing workers. So, if it goes ahead with hiring, it will need to increase the wage rates of its existing workers.

And this means the firm's profit-maximising level of employment and wages will both be lower than they would be under perfect competition.

In such a model, if the minimum wage rate is set at or below the marginal product of labour, this won't cause employment to fall and may cause it to rise. Monopsonistic models don't have an unambiguous prediction for the employment effect of a minimum wage.

A paper by Bhaskar, Manning and To, published in the Journal of Economic Perspectives in 2002, concluded that "a minimum wage set moderately above the market wage may have a positive effect or a negative effect on employment, but the size of this effect will generally be small".

It will be interesting to see how long it takes those many Australian economists who don't specialise in studying the labour market to catch up with this change in their profession's thinking.

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Hockey’s budget applies a chopper, not a brain

According to Treasury secretary Dr Martin Parkinson, the budget is replete with ''structural reforms''. According to his boss Joe Hockey, it will ''drive the productivity required to generate economic growth''. Sorry, not convinced.

As a vehicle for micro-economic reform, the budget gets less impressive the more I study it. Parkinson seems to be referring to reforms to the structure of the budget itself, which will build ''fiscal resilience'' over the coming decade.

That's true enough in terms of returning the budget to a sustainable surplus (business cycle permitting). In the process, however, the budget cuts will do little to raise the efficiency with which the government performs its own tasks, nor the efficiency of its interaction with private industries.

Rather than making what the government does more cost-effective, it just stops doing as much. It makes the federal government smaller, but not better. It's a giant exercise in cost-shifting: to people on pensions, to the young jobless, to university students, to the sick and, to the tune of $80 billion, to the states.

It's about crude spending cuts, not about using science to improve efficiency. Does anyone seriously believe imposing yet another temporary increase in the ''efficiency dividend'' on the public service will lead to cost savings without any decline in the quantity and quality of services provided to the public?

Hockey's talk of productivity improvement seems mainly a reference to the budget's increased spending on public infrastructure. I guess we shouldn't complain about the Liberals' belated recognition that adequate infrastructure increases the productivity of the private sector - it would be news to Peter Costello - but the money does need to be well spent to maximise the benefit.

Monuments and pork-barrelling do little for productivity. And I'm not convinced the Libs' bias - federal and state - towards expressways and against public transport is the way to get the greatest productivity gain.

Next exhibit on the micro-reform list would be the deregulation of university fees. The claim that this will unleash competition and so make the tertiary education ''industry'' a lot more efficient is so debatable I'll leave it for another day.

Along with Tony Abbott (St Ignatius, Riverview) and Christopher Pyne (St Ignatius, Adelaide), Hockey (St Aloysius, Sydney) has repudiated the Gonski reforms which would have put federal grants to schools on a needs basis. He's left grants to private schools unreformed and unmeans-tested, while grants to public schools will cover an ever-declining share of their costs.

Leaving aside questions of fairness (and partiality), this is a micro-reform negative. Adjusting grants to reflect students' disabilities would have done much to increase the skills, employability and workforce participation of kids at the bottom of the distribution. It could have been done more cheaply than Labor planned by reducing grants to privileged schools to compensate.

Medical services account for 9.5 per cent of gross domestic product, meaning we have few industries that are bigger, even though much of the industry is government-owned or heavily government-subsidised.

There is plenty of room for the reform of excessive schedule fees for certain procedures, perverse incentives and overservicing, particularly by the corporate sausage-machines that have been permitted to take over so much of general practice.

The doctors' union could be obliged to allow nurses and other health professionals to perform many routine procedures. Many evidence-based reforms could be implemented to reduce waste and increase productivity in public hospitals without reducing the quality of care.

Much could be done to reduce the cost of the pharmaceutical benefits scheme by taking a tougher line with foreign drug companies over generics and the ''evergreening'' of patents, not to mention the chemists' union.

Paradoxically, overseas experience says greater efficiency can be achieved by imposing a cap on the growth in total scheme spending, thus requiring medical representatives to make harder choices about which new drugs are really worth listing.

So what was done? Hockey introduced a $7 charge on GP visits, tests and scans that will be costly to collect and will get at the corporate overservicers by hitting every patient and will discourage the poor from seeing the doc, whacked up an already high co-payment for pharmaceutical scripts and slashed projected grants to public hospitals.

For good measure, Hockey stopped wasting money on all that preventive medicine stuff. Brilliant. Must have taken a genius to dream all that up.

Finally, ''corporate welfare''. The foreshadowed toughness didn't materialise, save for a brave decision to take the ethanol subsidy from a very generous political donor. But the opportunity for sharing the pain - and doing much to force change on a lot of corporate ''leaners'' - was missed.

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No one's trying to reduce government waste

Government waste is like the weather: everyone disapproves, but no one does anything about it. Oppositions accuse governments of creating it, but governments don't seem to try too hard to eliminate it.

And this doesn't seem to worry you and me too much because our main use for government waste is as an excuse to oppose every suggestion that we pay more tax - and, indeed, to resent the extortionate amount we pay already (always conveniently forgetting what we read time and again: that Australia's total tax burden is quite low compared with other advanced economies).

Were someone to magically eliminate all government waste, would we then be willing to pay more tax? Somehow, I doubt it.

This makes it likely we have an exaggerated view of the extent of waste. It suits us to believe waste is endemic. The sums we hear about seem huge - they are huge relative to our household budgets - but we're bad at putting them into the context of the billions of dollars our governments play with. We have no conception of how big Australia is when you add up its 8 million households and more than 1 million businesses.

That's my guess - that we have an exaggerated view of the extent of waste - but I can't prove it. I doubt if anyone has surveyed our impressions on the topic. Nor do we have any figures on the actual size of government waste, whether it's getting better or worse, or which side of politics has the worse record.

I guess no one's game to spend money measuring the extent of waste for fear of the talkback know-alls who'd say this was itself a waste of money.

And, of course, measuring waste wouldn't be nearly as easy as many of the sidewalk supervisors imagine. Waste is deceptively easy to allege, not so easy to prove and very hard to eliminate.

I've no doubt waste exists, and will always exist. There's plenty of waste in our own homes - the excess food we buy, the expensive gadgets we rarely use, the empty bedrooms, the kids who don't take advantage of the expensive educations we've provided, the holiday houses that are rarely occupied, the boats that rarely enter the water or leave their mooring - so why do we imagine governments could ever conduct their affairs without waste?

Because some degree of waste is inevitable it would nice to have some measure that allowed us to say whether its present level was excessive. And there are different types of waste. Often what the casual observer regards as waste merely reflects their lack of knowledge of all the circumstances.

Often there's a lot of subjective judgment involved. Is it wasteful to have bedrooms that are rarely occupied? Is it wasteful not to bother trying to rent out your holiday house when you're not using it? Or is it just the way you choose to enjoy your affluence?

At the government level, there's undoubted waste but there's also debatable waste. I may consider paying the family tax benefit to someone on your income a case of wasteful spending, but you probably disagree.

Tony Abbott and his colleagues are always accusing the Rudd-Gillard government of wasting money - as though waste was a recent invention - but when they're obliged to come up with their own list of spending cuts they're pretty light on. Too many possibilities that could cost votes.

It's no doubt a good thing oppositions carry on about waste - there'd probably more of it if they didn't. Even so, you don't get the feeling governments put much effort into hunting it down. They're always boasting about cracking down on petty welfare fraud, but not much else.

And when you consider how little publicity the media give to auditor-general certified waste, you get the feeling the public isn't all that worried about waste beyond using it to justify their objection to higher taxes.

One class of waste is ineffectiveness: government spending that doesn't achieve its stated objectives, or doesn't achieve them as well as some other program might. You'd think that, in this day and age, governments would put a lot of effort into assessing the effectiveness of their spending programs, but in this we lag well behind the Americans.

Perhaps because of the crowing they know the Opposition might do, ministers and their department heads have little enthusiasm for reviewing the effectiveness of their programs. They don't want the auditor-general poking his nose in and what evaluation occurs is usually pretty Mickey Mouse.

In the US, by contrast, it's common for Congress, when passing spending bills, to earmark a small proportion of the funds for program evaluation and to specify the rigorous methodology to be used. They've even got to the point where they're using randomised controlled trials. You have a treatment group and a (non-treatment) control group and you allocate participants between the groups by the toss of a coin.

Provided both groups are big enough, this approach makes it more likely the differences in outcomes between the two groups are the result of the treatment rather than extraneous factors.

Such an approach, which is widely used in medical trials, could be used to evaluate many - but not all - social spending programs.

And Dr Andrew Leigh, a federal Labor backbencher and former economics professor, has moved a private member's bill proposing we do just that. I'd like to see Abbott and the soon-to-be-elected O'Farrell government promising rigorous evaluation of spending programs. That would test their sincerity. And the Baillieu government in Victoria could get right in and do it now.

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