GDP slows as population slows

When is slower economic growth not such a bad thing? When it's caused by lower growth in the population.

If that puzzles you, you're a victim of the economists' practice of focusing on growth in gross domestic product rather than GDP per person.

Nigel Ray, a deputy secretary of Treasury, acknowledged in a speech to the Australian Business Economists this week that last financial year, 2014-15, the economy recorded its third straight year of below-trend growth.

"This means Australia is now in a prolonged period of below-par growth, the likes of which we have rarely seen outside of a recession," he said.

We'll be seeing the national accounts for the September quarter on Wednesday, but they're unlikely to show much improvement.

Reserve Bank heavies have been hinting at it for months, but this week Ray made it official: the economy's trend rate of growth is actually lower than the econocrats had been assuming in recent years.

But what exactly is "trend" growth? Good question because there are actually two versions of it (or three if you include the Bureau of Statistics' practice of referring to its smoothed seasonally adjusted estimates as "trend" estimates).

The backward-looking version of trend is the economy's average actual rate of growth over past 10 years or more. Since 1976-77, for instance, real GDP has grown at an average rate of 3.1 per cent a year.

If nothing in the economy ever changed, the backward-looking version of trend would be the same as the forward-looking version, but things do change.

The future trend rate of growth is also known as the economy's "potential" rate of growth, the maximum rate at which it can grow over the medium-term – periods of five or 10 years or so – without causing a big problem with inflation.

The economy's potential rate of growth is the rate at which its ability to produce goods and services is growing.

This, therefore, refers to the supply side of the economy. The supply side involves combining the economy's three "factors of production" – land, labour and capital – to produce goods and services.

Here, "land" includes natural resources and "capital" means man-made, physical capital, such as buildings and equipment, but also roads and other public infrastructure.

But the economists' custom is to view the economy's supply side – its capacity to produce goods and services – through the perspective of just one factor, labour.

So the economy's potential output is seen as being determined by "the three Ps": population, participation and productivity. Potential growth in production is determine by growth in the population of working age (everyone 15 and over) plus change in the rate at which people of working age choose to participate in the labour force by working or seeking work, plus growth in the productivity of labour (average output per hour worked).

Of course, the economy's potential to supply goods and services is only half the story. How much is actually produced in any period will be determined by the demand for goods and services at the time.

Demand can't exceed supply (when it tries, the excess demand that can't be satisfied from imports just forces prices up), but it can fall short of potential supply. When it does, labour is unemployed or underemployed (people not working as many hours as they want to) and factories and offices have idle capacity.

That's the position we've been in for the past three years: the growth in our demand for goods and services has been falling short of the growth in our potential to supply them. So when the econocrats say growth has been "below trend", that's what they mean.

And every year that actual output falls short of our potential output we get a widening in what economists call "the output gap", which will be manifest in rising unemployment or underemployment as well as unused production capacity in factories and offices.

Whereas we usually think of potential output as an annual rate of growth, the output gap is measured as the difference between the absolute levels of potential and actual output.

The size of the output gap is an indicator of the failure of the managers of the macro economy to achieve their goal of keeping its actual growth in line with its potential growth – that is, to keep it growing at full capacity or "full employment" (of all the factors of production, not just labour).

The continued existence of the business cycle means they can never achieve this goal, of course, but it's still their job to try.

The size of the output gap is also a measure of the extent to which a recovering economy can for a few years grow faster than its trend (potential) rate without that causing any inflation problem. A period of above-trend growth is actually the only way to eliminate the output gap and get the economy back to growing at its full-employment rate.

For some years the econocrats' estimate has been that the economy's potential or (forward-looking) trend rate of growth is 3 per cent a year, compared with its actual growth over the year to June of 2.3 per cent.

Ray said this includes an assumption that the working-age population grows by 1.75 per cent a year, its actual rate over the past 10 years. But now actual growth has slowed to 1.5 per cent because of a decline in holders of temporary visas and lower net migration from New Zealand.

So Treasury has cut its estimate of trend (potential) growth to 2.75 per cent, thereby reducing its estimate of the size of the output gap.

Why is this not such a bad thing? Because, although the growth in workers helping to produce goods and services is likely to be lower than we thought, there'll also be fewer people we have to share those goods and services with. GDP per person shouldn't be much affected.

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Shift to services is boosting exports and jobs

For economy watchers, the most fascinating game in town is the continuing effort to explain why employment and unemployment are performing better than you'd expect while growth in the economy has been so modest.

Despite the Bureau of Statistics' latest national accounts showing that real gross domestic product grew by just 2.3 per cent over the year to March, its smoothed seasonally adjusted labour force figures show employment growing by 2.1 per cent – or 240,000 jobs – over the year to July, with the rate of unemployment seeming to have stabilised at about 6 per cent.

So far in the Reserve Bank's efforts to explain this puzzle, we've heard that it's probably a consequence of slower than expected population growth, helped by surprisingly weak growth in wage rates.

But now an assistant governor of the Reserve Bank, Dr Christopher Kent, has used a speech to the Economic Society in Brisbane to add a third factor: the employment consequences of the economy's accelerated shift from goods to services.

Recent figures show that total population growth has slowed from 1.8 per cent in 2012 to 1.4 per cent in 2014. This slowdown is mainly the result of a decline in the rate of net immigration as skilled workers on temporary 457 visas attracted by the resources boom leave for home when their jobs end, and Kiwi workers go home or stay home.

Slower population growth means slower growth in demand but, equally, slower growth in the population of working age and thus in the economy's supply-side potential or "trend" rate of growth.

This has prompted the Reserve to lower its growth forecasts for 2016 a fraction but eliminate its earlier forecast of rising unemployment, leaving it little changed over the next 18 months.

Since the working population hasn't grown as fast as had been expected, this implies the improvement in the productivity of labour has been a fraction greater than first thought.

Last week's figures from the bureau show wage rates rising just 2.3 per cent over the year to June. Wage growth has slowed to a similar extent as happened in the recession of the early 1990s, even though unemployment has risen by much less than it did then.

Kent says wages may have become more flexible over time and there may have been some general decline in the bargaining power of labour.

Whatever, "low wage growth across the economy has enabled firms to employ more labour than would otherwise have been the case".

But Kent says his sense is that "low wage growth only goes some way to explaining the recent pick-up in labour demand".

Now the likely role of a change in the composition of economic activity. Consumer spending, home building and net exports of services (that is, exports of services minus imports of services) have grown reasonably strongly over the past year, even though overall GDP growth has slowed a fraction.

Surveys suggest that business conditions for firms providing services to households have improved greatly since mid-2013. Conditions for firms providing services to businesses are above average. But those for firms producing or distributing goods remain below average.

These survey results line up reasonably well with employment growth in the three sectors. They also fit with the continuing weakness in business investment spending.

Kent's figuring shows, on average, each worker in the household services sector requires the backing of only about $100,000 worth of capital equipment, whereas each worker in the goods sector (including mining) requires capital equipment of almost $400,000.

Get it? If the fastest-growing parts of the economy are labour-intensive, they can grow and create more jobs without this requiring the same degree of increase in business investment spending and, hence, the same degree of overall growth in the economy.

This compositional change in demand from goods to services – from capital-intensive to labour-intensive industries – is a long-term trend.

But Kent argues there is also a cyclical element to it, as mining investment unwinds and growth in housing construction and consumption – which is increasingly dominated by services – picks up.

Another part of it is that the fall in the dollar has encouraged Australians and foreigners to direct more of their spending to Australian tourism, education and business services.

Over the past three years, the extra workers employed in service industries have outnumbered the extra workers employed in the goods sector by five to one.

It adds up to two things. With slower population growth, we can grow more slowly without being worse off materially. And we don't need to grow as fast to get unemployment falling.

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Why the economy's slow growth may last

The biggest economic story last week wasn't all the wishful thinking about raising the goods and services tax, it was Reserve Bank governor Glenn Stevens' warning that the economy's "potential" rate of growth may be lower than we've assumed.

Predictably, those commentators who did see the significance of this news were too busy putting their own spin on it to make sure what Stevens' said was widely taken in. So let me have a go.

The macro managers' long-standing belief that the economy's "trend" rate of growth is 3 per cent a year or a fraction more has been challenged by the Bureau of Statistics' labour force estimates showing that, over the past year, the rate of unemployment has stabilised at 6 per cent.

Trouble is, the latest national accounts show the economy growing by only 2.3 per cent over the year to March. This is well below the trend rate that, almost by definition, is the rate at which the economy must grow to hold the unemployment rate steady.

How is this discrepancy explained? Stevens ran through the range of possibilities. Maybe employment hasn't been growing as strongly as the figures say at present. Maybe the economy has been growing more strongly than the figures say at present.

Or maybe part of the surprisingly strong growth in employment is explained by the unusually slow growth in wage rates, which would be saving some jobs and creating others.

The final possibility – and the one to which Stevens gives most weight – is that the trend rate of growth is lower than we've assumed, thus allowing unemployment to stabilise at a lower rate of economic growth than we've assumed.

Economists use the term "trend" in both a backward-looking and a forward-looking sense. If you calculate our average actual rate of growth over the past 10 or 20 years, this must have been our "potential" growth during that period.

If nothing in the economy has changed over that time, it should also be our average, trend rate of growth in the coming five or 10 years.

However, things do change – the population ages, for instance – so economists have to make guesses about what our potential growth rate will be in the future.

Our potential growth rate is the maximum rate at which the economy can grow on average over the medium term without a causing a serious inflation problem. It's set by the economy's supply side.

It represents the average rate at which the economy's capacity to produce goods and services is growing. And this is usually thought of as being determined by the rate of growth in the working population plus the rate of improvement in the productivity of labour.

(Whether in any particular year the economy is growing at a rate below, at or above its potential growth rate is determined by the strength of demand at the time. However, the economy can grow faster than its potential "speed limit" only for as long as it has idle production capacity to use up.)

But this is where those commentators who cottoned on to the significance of Stevens' views jumped to their own conclusions about what was causing the suspected slowdown in potential growth. They assumed it must be caused by a slowdown in labour productivity improvement.

Why? Because this fits well with the economists' (including Stevens') long-running campaign to persuade us to undertake more micro-economic​ reform so as to raise productivity and, hence, material living standards.

What they missed in their missionary zeal was Stevens' clear indication that he thought the culprit was slower-than-expected population growth.

The econocrats' figuring suggest a potential growth rate of 3 per cent would be explained by population growth of 1.7 per cent to 1.8 per cent a year, plus growth in labour productivity of 1.2 per cent to 1.3 per cent a year.

So their expected rate of productivity improvement is already pretty low, while the end of the mining construction boom and slow growth generally have seen population growth slow to 1.5 per cent a year or less as the net intake of workers on temporary 457 visas falls and Kiwis go home to a faster-growing economy.

The other thing the missionaries missed was Stevens point that, to the extent the lower trend rate is caused by lower population growth, it shouldn't involve any slower rate of improvement in our material living standards, as measured by growth per person.

Missionary micro-economic reformers won't win lasting converts by misrepresenting our present position, nor the outlook for growth. Their pessimism about future productivity improvement isn't supported by our more recent performance. It's little more than a guess.

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Slower immigration keeps unemployment steady

While we're busy scaring ourselves silly imagining all the terrible consequences that may or may not flow from the turbulence in the eurozone and China, forgive me for intruding with some good news closer to home: unemployment has stopped rising.

The employment figures we got from the Bureau of Statistics this week confirm – and so make a lot more believable – the amazing figures we got a month ago saying the official rate of unemployment had stabilised at 6 per cent.

Barring some unexpected disaster, it's now looking less likely the Reserve Bank's forecast that unemployment will rise to 6.5 per cent by June next year will be realised.

Let's cut through the month-to-month volatility that so many in the markets and media love by sticking to the smoothed seasonally adjusted estimates known as the "trend" figures.

They show that total employment grew by 215,000 over the year to June, an increase of 1.9 per cent. More than half these extra jobs were full-time.

Since the labour force – all those people either in a job or actively seeking one – grew at about the same rate as employment, this was sufficient to get the rate of unemployment back down to where it was in June last year – 6 per cent.

And this happened despite the rate of participation in the labour force – the proportion of the population aged 15 or over who were either employed or unemployed – rising from 64.7 per cent to 64.8 per cent during the year. Not bad considering the retirement of the baby-boomer bulge is working to lower the participation rate.

As I say, this is the same story the figures were telling us a month ago. So where have the extra jobs come from? Well, Kieran Davies, of Barclays bank, has used somewhat different figures – they say we had employment growth of 240,000 over the year to May – to tell us.

He follows the Reserve Bank's practice of splitting the economy into five broad sectors: household services (including accommodation and food services, education, health, recreation and other services), business services (information technology, media and communication, finance, real estate services, professional services and administrative services), goods (farming, mining, manufacturing, utilities and construction), distribution (retail and wholesale trade and transport and storage), and public administration.

Davies found very strong jobs growth in household services of, in round figures, 180,000, with strength in healthcare (90,000), accommodation and food services (50,000), and recreation and arts (40,000).

He makes the point that household services account for a third of total employment, and have driven total jobs growth since the global financial crisis.

Business services, which account for almost a fifth of total employment, have been the next most important sector, with growth of about 80,000. This was driven by professional services, up 90,000, offset by falls in employment in other categories, such as real estate services (20,000) and finance (10,000), but small gains in other categories.

Modest contributions to total jobs growth came from goods distribution (20,000) and public administration (10,000).

Against this, however, there were job losses in mining (30,000), farming (30,000), manufacturing (5000) and utilities (5000), which more than offset jobs gains of 20,000 in construction.

As you see, as well as this quite strong growth in employment overall, there's been a change in the composition of employment, with relatively small contractions in various goods industries more than offset by big increases in service industries.

If this news of strong overall employment growth comes as a shock to you, that's hardly surprising. The economy's been growing at below its "trend" (medium-term potential) growth rate of 3 per cent for a number of years.

And it's often repeated that the economy has to grow at its trend or potential rate of 3 per cent a year just to stop unemployment rising.  (This 3 per cent rate of growth in the economy's potential capacity to produce goods and services comes from labour force growth of 1.7 or 1.8 per cent a year, plus growth in the productivity of labour of 1.3 or 1.2 per cent a year).

So, with real gross domestic product growing by just 2.3 per cent over the year to March (and needing to achieve an unlikely 0.8 per cent growth in the June quarter to achieved the Abbott government's budget-time forecast of average growth of 2.5 per cent in 2014-15), how on earth is it possible for employment to be growing fast enough to hold unemployment steady?

Well, one possibility is that the economy's actually growing a lot faster than the national accounts say it is, but this doesn't seem likely.

A more likely explanation is that the economy's potential rate of growth is no longer as high as 3 per cent a year. It's more likely to have fallen to 2.75 per cent – or even 2.5 per cent, as some are suggesting.

Why? Because slower growth in the population than we've had in recent years –  slower than the econocrats were expecting – is causing slower growth in the labour force.

Population growth is slower because fewer Kiwis are coming to Oz and more are going back home where, for the moment anyway, the economy's prospects are brighter. As well, the end of the mining construction boom means fewer workers and their families are coming in under temporary 457 visas.

If the economy's potential growth rate is lower, that means we can stabilise unemployment at a lower rate of actual growth. In our present circumstances, employment growth is probably being encouraged by the lower dollar and the exceptionally slow growth in wage rates.

Note that when the economy grows more slowly because the population is growing more slowly, we're not left worse off in terms of growth in income per person. But lower immigration does make it easier to get on top of unemployment – something economists prefer not to mention.

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How growth can make us worse off

Just about every economist, politician and business person is a great believer in a high rate of immigration and a Big Australia. But few of them think about the consequences of that attitude – which does a lot to explain our economic problems.

The latest figures from the Bureau of Statistics show our population grew by 1.4 per cent to 23.6 million in 2014. Less than half this growth came from natural increase (births exceeding deaths), with most of it coming from net migration.

When I saw the 1.4 per cent growth figure, I thought it much of a piece with the 1.5 per cent growth over the year to September. It confirmed us as having one of the fastest growing populations among the advanced economies.

But, the Business Bible assured us, growth of 1.42 per cent was a big worry. It was clearly less than the 1.49 per cent average rate of the past 15 years and was, indeed, our weakest growth in eight years.

Slower population growth meant slower growth in real gross domestic product and this would also make it harder to get the federal budget back into surplus, we were told.

Really? This is crazy talk. It shows even our economists have turned off their brains on the question of immigration and lost their way between means and ends. Now they believe in growth for its own sake, not for any benefits it may bring us.

Of course slower growth in the population means slower growth in the size of the economy. But what of it? What do we lose?

The economic rationale for economic growth is that it raises our material standard of living. But this happens only if GDP grows faster than the population grows. So it doesn't follow that slower GDP growth caused by slower population growth leaves us worse off materially.

That would be true only if slower population growth caused slower growth in GDP per person. I suspect many people unconsciously assume it does, but where's the evidence?

I doubt there is any. The most significant recent study, conducted by the Productivity Commission in 2006, concluded that even skilled migration would do little to increase income per person. And what little growth the commission could find was appropriated by the new arrivals.

I doubt it's by chance that economists rarely, if ever, adjust the GDP figures they obsess about for population growth. Meaning we're constantly being given an exaggerated impression of how well we're doing in the materialism stakes. I can't remember GDP per person rating a mention in the budget papers.

Politicians are always boasting about record government spending on this or that, but they never make allowance for population growth in making such claims. (Why would they when often they don't even allow for the effect of inflation?)

As for the claim that slower population growth will make it harder to reduce the budget deficit, it reveals just how unthinking we've become on immigration. It's true enough that slower growth in the workforce means slower growth in tax collections.

But is that all there is to it? What about the other side of the budget? Aren't we assuming a bigger population is costless? Skilled immigrants and their dependents never use the health system? They don't have kids needing to be educated?

They don't add to traffic congestion, wear and tear on roads and 100 other taxpayer-provided services? Since there's often a delay while they find jobs, who's to say budgets, federal and state, wouldn't be better off with fewer immigrants?

But what's strangest about the economic elite's unthinking commitment to high immigration is the way they wring their hands over our weak productivity growth and all the "reform" we should be making to fix it, without it crossing their minds that the prime suspect is rapid population growth.

It's simple: when you increase the population while leaving our stock of household, business and public capital unchanged, you "dilute" that capital. You have less capital per person, meaning you've automatically reduced the productivity of labour.

So you have to do a lot more investing in housing, business structures and equipment and all manner of public infrastructure – a lot more "capital widening" – just to stop labour productivity falling.

The drive for smaller government – and the refusal to distinguish between capital and recurrent government spending – simply doesn't fit with a commitment to rapid population growth and a rising material standard of living.

Lower immigration would help reduce a lot of our economic problems – not to mention our environmental problems (but who cares about them?).

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We're not taking productivity seriously

Given our obsession with materialism, productivity "isn't everything, but in the long run it is almost everything," as Paul Krugman famously said. If so, the intergenerational report's consideration of the topic is quite inadequate.

It's partial in both senses. It mentions most of the key factors that influence productivity improvement - defined as increased goods and services produced per hour worked - but doesn't do justice to many, including climate change.

That's partly because, though the report purports to be about the future of the economy, its real target is Treasury's eternal top priority, the future of the budget balance.

But it's also because the econocrats are leading us towards their preferred policy response to our alleged productivity problem and away from those responses their "priors" - preconceived beliefs about how the world works - cause them to disapprove of.

There are two broad approaches to government efforts to improve productivity: one which involves more intervention and spending and one which involves less intervention and little change in spending. Guess which one Treasury's priors lead it to favour?

For the past 200 hundred years, most of the world's productivity improvement has come from technological advance - people inventing better machines and thinking of better ways to do things.

But the other fish Treasury wants to fry prompt it to embrace an extreme view held by a few American economists that we've entered a period of much less rapid technological change.

When you consider all the disruption the digital revolution is unleashing on so many industries this is hard to believe.

In the era of the knowledge economy, you'd expect much long and earnest discussion about what governments should and shouldn't be doing to encourage acquisition of the "human capital" that comes from education and training.

Should we be cutting budgetary support for science and research and development? Is now the right time to be pushing university funding off the budget and on to students and universities' money-making schemes?

Why would a government that professes to believe in "equality of opportunity" welch on its professed support for the Gonski reforms to school funding? Why would it view Gonski as about private versus public rather than about lifting the future participation and productivity of kids at the bottom of the distribution?

Instead, the issue of human capital is airily dismissed with the line that "there is little evidence that slower productivity growth has been the result of inadequate investment in skills, education and innovation more broadly".

Maybe. But it's probably equally true there's little evidence it hasn't been. All you're really saying is that there's little evidence - because we've never been willing to run to the expense of adequately measuring such a vital ingredient in our future wellbeing.

The other key element of productivity improvement that gets short shrift is public infrastructure spending. To what extent are its inadequacies limiting the productivity of businesses and adding to commuting times (an important part of our wellbeing that doesn't show up in gross domestic product)? But do workers who spend an hour getting to work arrive at their productive best?

No discussion of our present and future productivity performance is adequate without assessment of the role being played by our policy of high immigration. But all we get is the throwaway line that "there is some evidence that" high levels of migration increase productivity because our focus on skilled migration raises the workforce's average skill level and because "migrants can be highly motivated".

This is true and quite dishonest at the same time. It minutely examines the dog in the room while studiously ignoring the elephant. What economists know but try not to think about - and never ever mention in front of the children - is that immigration carries a huge threat to our productivity.

The unthinkable truth is that unless we invest in enough additional housing, business equipment and public infrastructure to accommodate the extra workers and their families, this lack of "capital widening" reduces our physical capital per person and so reduces our productivity.

Think of it: the very report announcing that our population is projected to grow by 16 million to 40 million over the next 40 years doesn't say a word about the huge increase in infrastructure spending this will require if our productivity isn't to fall, nor discuss how its cost should be shared between present and future taxpayers.

No, none of that. Just another repetition of that peculiarly Australian doctrine that pretty much the only way to improve productivity is to engage in unceasing micro-economic reform.

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Treasury under new management

How much does the Treasury's view of the world change when a prime minister comes to power, sacks the head of Treasury (and his heir apparent) and replaces him with his own hand-picked man from outside the public service?

That's what the economic cognoscenti were asking last week when our first political appointment as Treasury secretary, John Fraser, made his first public appearances at a Senate estimates hearing and as a speaker at a conference of the Committee for Economic Development of Australia.

Fraser had risen to the rank of deputy secretary when he left Treasury in 1993 to make his name and fortune as an investment banker at the global level of the UBS bank. It's hard to imagine such an old and rich chap would hang around long if he found his advice wasn't being heeded.

From what he's said so far, you don't get the feeling Fraser has spent the past 22 years keeping tabs on the Australian economy or keeping abreast of the latest applied research on fiscal policy. Even so, he's a man of strong and confidently held opinions, who isn't afraid to tell you about them.

His views were pretty conservative when he left Treasury, at a time when the views of Treasury itself were more cautious than they've been in recent years, and his time as a chief executive is unlikely to have radicalised him.

Dr Martin Parkinson and Dr Blair Comley seem to have been sacked for their lack of scepticism about climate change, so we can presume Fraser doesn't share that failing. I may be wrong, but I don't see him as someone who wastes much time worrying about "wellbeing frameworks".

We know from his evidence to the Senate that he's a great admirer of Ronald Reagan's tax cuts of the early 1980s (which did so much to lay the foundations for America's present towering public debt), but has "old-fashioned" views about the evil of public debt.

He is sceptical about using the budget to stimulate the economy when it's very weak – which means he's invalidated one of the best arguments for getting debt down: the need to "reload the fiscal cannon" ready for the next recession.

And he thinks the policy of "austerity" practised in Britain and (by default) America has been a great success. This opinion he expressed to the Senate and backed up with figures in his later speech.

To silly people on the left, "austerity" is a swear word you slap on any budget saving you disagree with. But it really means a policy of cutting the budget deficit hard even while the economy is very weak.

The lefties never understood that Joe Hockey's first budget was carefully crafted to involve minimal net cuts to the deficit in the first three years, with the big hit delayed until 2017, when the economy was expected to be back growing strongly.

So, is true austerity about to come to Oz under the advice of the new Treasury boss? You might think so. Fraser says "we need to start now" and repairing the fiscal (budgetary) position is "an immediate priority".

But I'm not so sure. Later in his speech he advocates "committing now to savings measures that build over time to deliver a return to surplus over the medium term". And asked if now was the time to cut savagely considering the weak outlook, he said the coming budget would have to be "tailored to the situation".

While much of what Fraser has said so far is what you'd expect of an Abbott appointee, some of it isn't. His summary of how the budget got into its present state doesn't put all the blame on Labor, but acknowledges the role of excessive tax cuts and spending by the Howard government.

And while noting that government spending has grown at an average real rate of more than 4 per cent a year since 2007-08 (mainly under Labor), he also noted that it grew by about 3.5 per cent a year over the four years to 2007-08 under the sainted Howard government.

He is sharply critical of the increase in "middle-class welfare" in Howard's last years, including Peter Costello's (obviously unsustainable) superannuation changes, which he highlights for reform.

And unlike the huge majority of economists, he frankly admits the great drawback to using immigration to boost economic growth: it "places additional demands on government budgets in areas such as infrastructure, health and education".

Maybe high immigration, but inadequate investment in business equipment, housing and public infrastructure, help explain why our rate of productivity improvement isn't as great as Fraser says we need.

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You were a stranger, so we wouldn't take you in

Do you get the feeling we're becoming a more selfish nation? While other countries were pitching in, we hesitated until this week to send experts to help stem the outbreak of Ebola. Sending people to risk their lives in wars doesn't seem a problem, but to send people for humanitarian reasons is asking too much when their personal safety can't be guaranteed.

This comes on top of our decision to slash the planned increase in official overseas aid. Sorry, but we just can't afford to be so generous. Others may look on Australia as among the richest countries in the world, but they don't understand we have our own problems.

We're running a budget deficit, and will be for many years yet. Borrowing money to cover gifts to poor foreigners hardly makes sense. And don't try telling me there are other, less-deserving people whose assistance could be cut.

As Joe Hockey has explained, our top income-earners are already being taxed too heavily to cover our bloated and unsustainable government spending, so this budget was designed to spare the lifters and require the leaners to bear a fairer share of the burden. And how could we make our own pensioners and sick people tighten their belts while we're being so generous to foreigners?

Hugh Mackay, the social commentator, tells us we've reversed the original meaning of the saying that charity begins at home. It used to mean don't demand charity of others until your own giving is up to scratch, but now it means we shouldn't be helping outsiders while any of our own remain in need.

But nowhere is our lack of charity more evident than in our hard hearts towards boatpeople. How dare they turn up on our doorstep uninvited, expecting us to put them up?

In the past, when asylum seekers were found to be genuine refugees, with a "well-founded fear of persecution" should they return to their own country, they were allowed to stay and included in our annual quota for "humanitarian" immigration.

For years we've discharged our obligation to help with the world's asylum problem by accepting just under 14,000 refugees a year for settlement in Australia. If that sounds like a lot, it represents 0.06 per cent of our population of 23.7 million. It's little more than 7 per cent of our total permanent settler intake of 190,000 a year.

For some reason - troubled conscience, perhaps - the Gillard government upped the humanitarian intake to 20,000 a year in 2012-13, but fortunately the Abbott government has returned it to fewer than 14,000.

Much more affordable. Our loathing of boatpeople is so intense that we tend to think of them as nothing more than a drain on the public purse. And for the first few years that's true.

But in a speech Professor Graeme Hugo, a demographer from the University of Adelaide, delivered to the annual conference of the Kaldor Centre for International Refugee Law in Sydney on Monday, he argued that humanitarian settlers eventually make a significant economic contribution.

Consistent with our more self-interested approach to immigration, these days we favour those who possess the skills - including language skills - of which we're most in need. Compared with these people, refugees are unpromising material for building the economy.

Some may have mental health issues arising from their treatment in their home countries, their experiences in transit or the kindly reception they receive from us. Many have low levels of literacy and limited skills and qualifications; few have great proficiency in English.

Those who do have qualifications will have lost their documentation, or won't have them recognised. They know little about our labour market, they often lack family networks in Australia, their family is split up and they bring no savings with them.

So, yes, in their early years many refugees aren't in the labour force and, among those who are, unemployment is high - higher than for other immigrants. Many of the younger ones you may expect to be working are still in the education system, catching up.

And yet their participation in the labour force rises with the length of time they've been here, converging towards the participation rate of the Australia-born, Hugo says. And their second generation end up having higher participation levels than Australia-born. They're also more highly qualified than Australia-born.

The humanitarian intake has other attractions. Refugees tend to be younger than other migrant groups, with a higher proportion of children, meaning they make a greater contribution to slowing the ageing of the population.

Their fertility is slightly higher. Predictably, their rate of returning home is very low compared with other migrants, and the proportion willing to settle in regional areas - almost 18 per cent - is high and rising.

Personal experience and common sense suggests all migrants who uproot themselves to move to Australia have a fair bit of get-up-and-go, with a determination to make the most of the new opportunities for themselves and, particularly, their kids. Hugo says people who move tend to be among the risk-takers.

Migrants tend to be more entrepreneurial - more likely to start their own businesses - and there's increasing evidence humanitarian settlers contain a disproportionate share of entrepreneurs.

On the BRW Rich List in 2000, five of the eight billionaires came from a refugee background. I wonder how generously they gave to charity.

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We're a nation of stay-at-homes

Would you be surprised if I told you the resources boom and its two-speed economy had led to a big increase in the number of people shifting between states? No, I thought not.

Well here's my surprise: it hasn't gone up, it has gone down. Research by Professor Jeff Borland, of the University of Melbourne, finds that the rate of interstate migration has declined over the past decade.

The eternal lament of oldies (me included) is that we're getting more and more like America. But this is one respect in which we aren't. The Americans are inveterate movers between states, but we have never moved as much as they do, and now even fewer of us are doing it.

"Australians have never been big movers," Borland says. "Most of us complete our schooling in the same state. We're not likely to shift states to find employment if we lose our jobs. And when we move in retirement, this is mostly to another place in the same state."

Borland's paper shows that, in 2003, the proportion of the population moving between states was 2.1 per cent. Last year it was just 1.5 per cent, a decline equivalent these days to 130,000 fewer people.

This was the lowest rate for at least 40 years. And it was no flash in the pan. It was the continuation of a decline that's been occurring steadily for 10 years. The rate of interstate migration rose between the mid-'70s and the late-'80s, then stayed pretty stable at about 2 per cent a year until the early noughties.

The rate of decline was reasonably similar in all states, with one exception. No, it wasn't Western Australia. It was Queensland. And Queensland's share of the decline wasn't disproportionately smaller than for the other states, it was larger.

The decline has occurred among people of all ages. But that's not to say people of all ages are equally likely to pack up and move interstate. They aren't.

Borland finds that the peak ages for state migration are the 20s and 30s. "People above 40 years move progressively less as they get older," he says.

If we take the example of the late 1990s, one in 25 people aged 20 to 24 moved interstate in the previous year, whereas for those aged 70 to 74 it was one in 200.

So why has interstate migration declined? If moving tends to be concentrated among people in their 20s and 30s, could such migration be down because, with the ageing of the population, people in that age range now constitute a smaller proportion of the total population?

No, the overall decline is explained by declines in all age groups, although it's true that the decrease has been larger at younger ages.

It seems clear to me that most interstate migration is work-related. Or, as Borland puts it, "suppose we think of the main rationale for interstate migration as being to match the location of the population to the location of jobs".

In that case, could the decline in movement between states be caused by less reallocation of jobs between states? Doesn't seem so. An index of the annual change in the distribution of employment by state shows no downward trend in the extent of change.

So what is the reason? Borland isn't certain, but he finds evidence to support the idea that the change is in the behaviour of recent immigrants to Australia, not that of people long resident here. There's been an increase in the correlation between the states immigrants first come to and the states where employment is growing fastest.

My guess is it gets back to the Howard government's move to a much greater proportion of skilled migration, with greater employer nomination of migrants via 457 visas. Migrants are now more likely to come straight to a particular job than to land in Sydney or Melbourne and start hunting for one somewhere in Oz.


RIVALRY between the Coalition and Labor can reach petty levels. The budget papers always had white covers until the Rudd government decided dark blue would be a good reform. Under the Abbott government they've reverted to white.

For many years the federal government spelt "program" the way this newspaper does. But John Howard, spiritual son of Bob Menzies, insisted it revert to the fancy English spelling. Labor changed it back to the no-bulldust way. Now Tony Abbott, spiritual son of Howard, has reverted to "programme".

Pedants who know their stuff know the Poms - including Shakespeare in his day - used the simple spelling until the 19th century, when it was prettied-up during a bout of francophilia.

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Hard to hear angels above the racist heartbeat

Scientists used to think chimpanzees - our close relatives - were a gentle, peace-loving species, until they observed their behaviour in the wild and found they could be quite murderous in the treatment of other chimps.

And what was it that caused them to become so vicious? The arrival of chimps from a different troop in the part of the forest they considered to be their territory.

I remembered this one day after failing to persuade a friend who took a dim view of boat people that her objections were unfounded. Whenever I knocked down one argument she'd just switch to another.

Our evolutionary history has left us with an instinctive fear of outsiders - people who are different, people who invade our territory to steal our food and our women or, in the contemporary context, to jump the queue and steal our jobs, overcrowd our schools (and win most of the prizes), overwhelm our culture, crowd out the rellos we're trying to get into the country, push up house prices and add to congestion on the roads.

You can call it racism or religious intolerance - the nation that invented the White Australia Policy can hardly object to that charge, except to say we're no worse than most nationalities and better than some.

But it's best thought of as xenophobia - a fear of foreigners, people who are different, who aren't one of us.

And it's so deeply ingrained in us - so visceral - it's not susceptible to rational argument. It would be nice if a greater effort by the media to expose the many myths surrounding attitudes towards asylum seekers could dispel the fear and resentment, but it would make little difference.

Our politicians have long understood that widespread dislike of newcomers, especially those of darker skin or strange religious practices, lay just beneath the surface and could be easily aroused. The politician or party that tapped this vein would draw much support.

For decades there was an unspoken agreement between the major parties to keep such tactics off limits. Their role was to avoid bringing out the worst in the Australian psyche.

But maybe 20 years ago that bipartisan approach began breaking down. Perhaps it was the rise of Asian immigration, perhaps the era of so many people arriving uninvited by boat.

It may be true we have a bigger problem with visitors arriving by plane and overstaying visas, but the more visible arrival of scruffy people on an overcrowded, leaky boat - the footage of which can be replayed many times, leaving an exaggerated impression of the numbers involved - seems far more threatening.

Perhaps it was the huge rise in the levels of sanctioned immigration in recent years, for which governments have failed to provide sufficient housing and public infrastructure.

Another factor was the advent of talkback radio, which gave greater currency to the disaffection of individuals, and then the rise of shock jocks who, in pursuit of ratings and commercial gain, where prepared to incite their listeners' resentments.

Pauline Hanson brought the issue crashing onto the stage of federal politics, forcing the major parties to respond. But politicians had begun walking away from their commitment to avoid politicising the issue much earlier.

Perhaps they couldn't avoid responding to public concerns; perhaps in the heightened contest between the parties they could no longer resist the temptation to gain an advantage over their opponents.

Some people blame it all on John Howard, but the harsh treatment of boat people began under his Labor predecessors. And whoever started it, once the embargo had been breached both sides got down and dirty.

Julia Gillard took the debate to a lower level before the election when she invited people to give their prejudices free rein. "People should feel free to say what they feel," she said. "For people to say they're anxious about border security doesn't make them intolerant. It certainly doesn't make them a racist."

To acknowledge we have an evolutionary predisposition to fear and resent outsiders is not to condone such attitudes. The process of civilisation involves gaining mastery over our base emotions which, if they once contributed to our biological "fitness", are now antisocial and counter-productive.

But if such attitudes are instinctive and impervious to rational argument, what's to be done now the pollies have let their standards fall?

I was at a loss to answer that until last week and the arrival in Sydney of that poor distressed orphan boy for the funeral of his father. Suddenly a crack appeared in the wall of prejudice against boat people. Tony Abbott and his immigration spokesman, Scott Morrison, got caught going beyond the pale in their pursuit of electoral advantage. It emerged that Morrison had earlier proposed exploiting the popular resentment of Muslims, but had been rebuffed by colleagues insisting the Liberals' long-standing commitment to a non-discriminatory immigration policy remain inviolate.

The minister, Chris Bowen, was widely criticised for his bureaucratic and insensitive treatment of the boy and his relatives. And it seems the episode has prompted Gillard to find the courage to lead.

"People easily fear change. People easily fear difference," she said. "It is the job of national leadership to reassure in the face of that fear, to explain to people that there is ultimately nothing to be afraid of."

What changed? Here's a clue: in their efforts to gratify and exploit public resentment of "illegals", governments of both colours have given the highest priority to preventing individual boat people from telling their stories to the media. They must continue to be seen as monstrous invaders, never as flesh and blood.

Our attitudes towards asylum seekers may be impervious to rational argument, but they're not to rival emotions - particularly the positive emotion of empathy.

Like all nationalities, Australians are neither good nor bad, they're both. Our leaders can play up to our darker side, or appeal to the better angels of our nature.

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Beware gurus selling high migration

The economic case for rapid population growth though immigration is surprisingly weak, but a lot of economists are keen to give you the opposite impression. Fortunately, the Productivity Commission can't bring itself to join in the happy sales job.

I suspect that, since almost all economists are great believers in economic growth as the path to ever higher material living standards, they have a tendency to throw in population growth for good measure. There's no doubt a bigger population leads to a bigger economy; the question is whether it leads to higher real income per person, thereby raising average living standards.

Of course, business people can gain from selling to a bigger market, regardless of whether the punters are better off. So I'd be wary of advice coming from economists employed by business or providing consulting services to business.

In 2006 the Productivity Commission conducted a modelling exercise to assess the effect of a 50 per cent increase in our skilled immigrant intake. It found that, after 20 years, real gross domestic product was only about 4 per cent higher than otherwise.

And the increase in real income per person was minor. What's more, most of the gains accrued to the migrants themselves, with the existing population suffering a tiny net decline in income. Why this lack of benefit? You'd expect the extra skilled labour to raise the proportion of the population participating in the labour force, thus boosting production per person.

But most of the productiveness of workers are achieved by the physical capital they're given to work with. So unless your extra workers are given extra capital equipment - a process known as "capital widening" - their productivity is likely to decline, thus offsetting the gain from having more workers.

Note, too, that we have to increase the housing stock to accommodate the migrant workers and their families, as well as providing the extra public infrastructure for a bigger population. So the migrants are paid to supply their labour, but the rest of us have to provide the extra economic and social capital they need if standards aren't to fall.

Last week Tony Burke, the federal minister responsible for developing a "sustainable population strategy" next year, released an issues paper to encourage discussion. It was accompanied by the reports of three advisory panels, including one on the economic aspects, led by Heather Ridout of the Australian Industry Group.

Ridout's report sets out to talk up the economic case for high migration by dispelling "myths" and pointing to hard-to-quantify benefits "often ignored by low-growth advocates when they skim the literature" (that's what they call a professorial put-down).

The main hard-to-quantify benefits left out of the Productivity Commission's modelling are the economies of scale arising from a bigger market. But why after all these years have economists been unable to produce good empirical evidence of something as straightforward as scale economies?

And why wax lyrical about unmeasurable benefits without mentioning unmeasurable costs? In its recent booklet on population and immigration, the commission acknowledges that as well as economies of scale there could be diseconomies.

The Ridout report objects that the commission's modelling measured the benefit of increased immigration only over 20 years. Sorry, but if you have to wait more than 20 years for the payoff you're not talking about a powerful effect.

A relatively new argument in favour of high immigration is that it could foster economic growth by countering to some extent the decline in labour-force participation caused by the ageing of the population. But, since immigrants age too, all this can do is put off the evil hour (not a course of action usually promoted by economists). To continue postponing the crunch you have to keep upping the dose of immigration.

The Productivity Commission is blunt: "changes in migration flows are unlikely to have a significant and lasting effect on the ageing of Australia's population".

The Ridout report argues that a faster-growing, immigration-fuelled economy would require greater levels of investment by businesses and in public infrastructure. This greater capital spending would generally involve investment in more productive capital equipment, as recent technological improvements will be embedded in the newer stock. In this way, faster growth of the size of the economy would drive the productivity gains that are central to advances in material living standards, we're told.

Huh? The proposition is that by taking on a need for considerable investment in capital widening (to provide the extra workers with the equipment and infrastructure they need to be as productive as the existing workers) we're increasing the scope for capital deepening (giving each worker more and better capital equipment).

Am I missing something? This is a twist on a common economists' argument I've never managed to fathom: we need to grow more and do more damage to the natural environment because when we're richer we'll be able to afford to fix the damage we've done to the environment.

The Ridout report asserts that provided population growth is "balanced and managed well", living standards will rise. It needs to be "matched by greater commitments to education and skills development, more and better investments in infrastructure, greater attention to the development of our cities and regions and to our natural environment".

In other words, to give business the extra population it wants but prevent this from worsening all those things, governments at all levels will really need to lift their game as well as spend a lot more. Turn in a perfect performance and high immigration won't be a problem.

I prefer the commission's way of putting it: "population growth and immigration can magnify existing policy problems and amplify pressures on 'unpriced' entities, such as the environment, and urban and social amenity".

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A few facts would be useful in the migration debate

If we are going to have great debate about whether we want a Big Australia, people will need a much stronger grasp on the factors driving population growth and immigration than they've shown so far.

This is the rationale for a useful booklet, Population and Immigration: Understanding the Numbers, issued by the Productivity Commission this week.

Over the past 50 years, Australia's population has averaged growth of 1.6 per cent a year, causing it to double to 22.3 million. This is faster than for most developed countries.

The growth in our population comes from two factors: natural increase (more births than deaths) and "net overseas migration" (more immigrants than emigrants).

Natural increase is relatively stable, averaging about 130,000 people a year, whereas net migration can vary a lot from year to year.

Our "total fertility rate" (the number of babies per woman) has risen a bit in recent years to 1.9, although it's only about half the peak it reached in the 1960s.

It's fallen over the decades because of more effective contraception, the higher education of girls, and married women wanting to return to the paid workforce.

It's recovered a bit in recent years because of a slight reversal of the trend for women to leave starting their families later and later. Women worry more about leaving it too late and, when they start a bit earlier, more couples are able to achieve the common desire to have two kids rather than one.

The commission doubts whether Peter Costello's baby bonus has had any significant effect on fertility.

Demographers put the population "replacement rate" at 2.1 children (the extra 0.1 is to allow for a few who die before being able to reproduce). Since our fertility rate has long been below that (as it is in most developed countries), without net migration our population eventually would start to fall.

However, natural increase has been kept positive by rising longevity (a falling death rate). Longevity has risen significantly over the past century because of improvements in public health measures, improved nutrition (from a rising material standard of living) and advances in medical science.

Since the 1980s, net migration has overtaken natural increase as the main contributor to population growth. In the 1970s it accounted for about 30 per cent of population growth but in the past 10 years it's grown strongly to now account for about 65 per cent of the growth.

Our long-term rate of population growth is 1.6 per cent but in recent years strong migration has caused growth to be higher than that, with a rise of 2 per cent in the year to June 2009. This included net migration for the year of 313,500.

This high level of migration - combined with Treasury's projection that our population could reach 36 million by 2050, Kevin Rudd's remark that he believed in a big Australia and public anxiety over boat people - has prompted the debate about Big Australia.

But there's a lot of confusion over the extent to which the government controls the level of immigration.

Immigrants can be divided into two streams: those coming permanently and those coming temporarily. Starting with the former, the government has a permanent migration program. Each year it decides on the maximum number of permanent immigrants it will take and this figure gets a lot of publicity.

The limits set for this financial year are unchanged from last year: a total of almost 169,000, being 114,000 places for skilled migration plus 55,000 places for families. The big increase in recent years has been in the skilled category.

Also in the permanent stream is the government's humanitarian program. Each year the government sets a limit of about 14,000 on the number of refugees it's prepared to let in. People who arrive by boat and are found to be genuine refugees are given permanent residence under this program.

But fewer than 3000 humanitarian places a year (less than 20 per cent) are given to people who apply after they get here. The rest apply overseas and the program doesn't increase to make room for onshore applicants.

So repeated TV footage of people arriving on overcrowded boats has left the public with a quite exaggerated impression of how many of them there are. Some people imagine it's boat people who explain the high levels of migration in recent years but that's quite wrong. Their numbers are trivial in the scheme of things and don't increase the modest total of refugees admitted each year.

Finally in the permanent stream come Kiwis. Just as you and I can move to New Zealand any time we choose, so Kiwis can come here without government permission.

But here's the trick: most of the growth in net migration in recent times has been in the short-term stream, accounting for about two-thirds of annual net migration. In June 2009, there was a stock of almost a million people in the country on temporary visas. The three main temporary categories are: overseas students (contributing 110,000 to net migration in 2007-08); long-stay "457" business visas (contributing about 35,000); and working-holiday visas (about 21,000).

Long-stay business visas can run for as long as four years. In principle, if there was no increase in the number of people in these three categories over time, they'd make no contribution to population growth. About the same number of people would be coming and going each year.

Similarly, if that was all there was to it, any increase in their numbers would make only a temporary contribution to population growth. Eventually the increase would stop and eventually they'd go back home.

But in recent years more than half the people with long-stay business visas have been granted permanent residency, as have about a third of the overseas students.

Now, it's important to realise the government imposes no limits on any of these categories. Overseas student numbers are driven by the efforts of Australian universities and private training colleges to attract paying customers. The long-stay business visa numbers are driven by employer demand for skilled workers not available locally.

But the government has recently more than halved its list of skilled occupations in short supply and tightened up on the overseas student category. Combine this with the high dollar and the troubles of Indian students in Melbourne and it seems likely the number of overseas students will now fall quite heavily.

It's a safe bet net migration won't grow nearly as fast in the next few years.

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Punters well aware of economic case against more immigration

The Big Australia issue has gone quiet since the election but it hasn't gone away. It can't go away because it's too central to our future and, despite Julia Gillard and Tony Abbott's rare agreement to eschew rapid population growth, the issue remains unresolved.

This year Rebecca Huntley of Ipsos, a global market research firm, and Bernard Salt of KPMG, a financial services firm, conducted interviews with business people and discussions with 13 groups of consumers, showing them two markedly different scenarios of what Australia could look like in 2020.

In the "measured Australia" scenario, governments limited population growth, focused on making our activities more environmentally sustainable and limited our economic links with the rest of the world.

In the "global Australia" scenario, governments set aside concerns about the environment, promoted rapid economic and population growth, and made Australia ever more a part of Asia.

Not surprisingly, the business people hated measured Australia and loved global Australia. But even though global Australia was described in glowing terms - ignoring the environment apparently had no adverse effects - ordinary people rejected it. And although measured Australia was painted in negative terms - all downside and no upside - there were aspects of it people quite liked.

The message I draw is that if governments keep pursuing rapid growth to please business they'll encounter increasing resentment and resistance from voters.

Considering the human animal's deep-seated fear of foreigners, it's not surprising resentment has focused on immigration. It's clear from the way in the election campaign both sides purported to have set their face against high migration that they're starting to get the message.

But at the moment they're promising to restrict immigration with one hand while encouraging a decade-long, labour-consuming boom in the construction of mines and gas facilities with the other. And this will be happening at a time when the economy is already close to full employment and baby boomers retire as the population ages.

Their two approaches don't fit together. And unless our leaders find a way to resolve the contradiction there's trouble ahead.

Business people support rapid population growth, which really means high immigration; there's little governments can do to influence the birth rate, because they know a bigger population means a bigger economy. And in a bigger economy they can increase their sales and profits.

That's fine for them, but it doesn't necessarily follow that a bigger economy is better for you and me. Only if the extra people add more to national income than their own share of that income will the average incomes of the rest of us be increased. And that's not to say any gain in material standard of living isn't offset by a decline in our quality of life, which goes unmeasured by gross domestic product.

The most recent study by the Productivity Commission, in 2006, found that even extra skilled migration did little or nothing to raise the average incomes of the existing population, with the migrants themselves the only beneficiaries.

This may explain why, this time, economists are approaching the question from the other end: we're getting the future economic growth from the desire of the world's mining companies to greatly expand Australia's capacity to export coal, iron ore and natural gas, but we don't have sufficient skilled labour to meet that need and unless we bring in a lot more labour this episode will end in soaring wages and inflation.

Peter McDonald, a leading demographer at the Australian National University, argues that governments don't determine the level of net migration, the economy does. When our economy's in recession, few immigrants come and more Aussies leave; when the economy's booming, more immigrants come and fewer Aussies leave. Governments could try to resist this increase, but so far they've opted to get out of the way.

To most business people, economists and demographers, the answer to our present problem is obvious: since economic growth must go ahead, the two sides of politics should stop their populist pandering to the punters' resentment of foreigners.

But it seems clear from the Ipsos discussion groups that people's resistance to high immigration focuses on their concerns about the present inadequacy of public infrastructure: roads, transport, water and energy. We're not coping now, what would it be like with more people?

And the punters have a point. In their instinctive reaction to the idea of more foreigners they've put their finger on the great weakness in the economic case for immigration.

As economists know - but don't like to talk or even think about - the reason immigration adds little or nothing to the material living standards of the existing population is that each extra person coming to Australia - the workers and their families - has to be provided with extra capital equipment: a home to live in, machines to use at work and a host of public infrastructure such as roads, public transport, schools, hospitals, libraries, police stations and much else.

The cost of that extra capital has to be set against the benefit from the extra labour. If the extra capital isn't forthcoming, living standards - and, no doubt, quality of life - decline.

If we don't build the extra homes - as we haven't been doing for some years - rents and house prices keep rising, making home ownership less affordable. To build the extra public facilities, governments have to raise taxes and borrow money. But they hate raising taxes and both sides of federal politics have sworn to eliminate government debt.

The interviews and discussion groups revealed both business people and consumers to be highly doubtful about the ability of governments - particularly state governments - to provide the infrastructure we need. As well they might be.

At present, our leaders on both sides are heading towards a future that doesn't add up.

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A sustainable Australia?

Clancy Auditorium, UNSW
Thursday, November 4, 2010

My strongest reason for opposing continuing high levels of net migration is my scepticism about the airy assurances from economists and others that continued population growth is compatible with an ecologically sustainable Australia. Economists offer these assurances not because they’ve thought deeply about Australia’s ecological carrying capacity - it’s not a subject they know much about - but because they’re used to thinking about the economy in isolation from the environment and because they have a suspiciously convenient faith in the ability of technological advance to solve environmental problems and faith in the ability of increases in man-made capital to substitute for the depletion of non-renewable resources, the over-exploitation of renewable resources, the degradation of waterways and soil, the destruction of species and the damage to ecosystem services (such as carbon sinks).

But since I’m no expert on ecology either, I’ll stick to something I know a bit about. It’s to warn non-economists that the contribution of immigration to increased material prosperity isn’t all it’s cracked up to be. There’s no doubt that net migration causes the economy to grow - to be bigger because it has more people in it. Businesses want a bigger economy because it gives them more people to sell to and profit from. From their self-interested perspective, that’s quite rational. But for economists and politicians it’s not good enough to assume that bigger is better, to believe in growth for the sake of growth. No, according to their narrow, materialist perspective, growth is only a good thing if it makes us better off, if it raises our material standard of living, if it increases real income per person.

Now here’s the thing: although economists don’t like to talk about it - don’t like to think about it - plenty of studies have shown that immigration does little or nothing to raise real income per person. What little gain there is goes to the immigrants themselves, not the pre-existing population that invited them in. This conventional but little-trumpeted finding is confirmed by the most recent study, undertaken by the Productivity Commission in 2006.

So why is it that adding extra workers tends not to raise the average standard of living? Well, it’s well understood by economists: it’s because all those extra people require additional spending on capital - ‘capital broadening’ as economists call it - if the average amount of capital per person isn’t to fall. The extra people need to be supported by additional capital in their private lives - more housing - additional capital equipment in the firms where they work, and additional public infrastructure: more roads, more public transport, schools, hospitals, power and water. Thus the economic benefit of having more workers is essentially cancelled out by the cost of providing the extra capital that needs to go with them and their families (most of which has to be borrowed from foreigners).

The fashion among economists at present is to ignore this glaring drawback and focus on more seemingly appealing arguments, such as that high immigration will reduce our problem with ageing (true but exaggerated) and Professor Peter McDonald’s argument that politicians don’t determine the size of our immigration, the needs of the economy do. There’s some truth to this, but then economists point to the resources boom and the massive increase in construction activity it involves and conclude we must open the immigration flood gates to avoid skilled-labour shortages and wage inflation. Actually, we only surrender our control over immigration to the economy when we proceed from the assumption that economic growth is pretty much the only thing that matters and that the role of the natural environment can be left out of the model.

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Does the economy depend on population growth?

Talk to University of Sydney Political Economy Society
May 4, 2010

There are a hundred political economy points I could and would like to make about immigration and population, but time doesn’t permit so I’m going to focus the more strictly economic question: does the economy depend on population growth?

I’ll start by stating upfront where I’m coming from on population: I believe we should do what we can to limit the growth of our population, and do that by focusing largely on immigration. Net immigration has accounted for about half our population growth over recent decades, with natural increase (births minus deaths) accounting for rest. Immigration (and the subsequent children of immigrants) would account for well over half of the 60 per cent growth in the population, from 22 million to 36 million over the 40 years to 2050, as mechanically projected by Treasury - the projection that’s stirred up so much debate.

The reason for focusing on immigration rather than natural increase is that fertility is much harder and more controversial for governments to attempt to influence. In any case, the fertility rate is running just below the 2.1 babies per woman needed just to hold the population constant over the longer term. Arithmetically, some net migration would be necessary to stop the population starting to fall by around the middle of the century. So immigration is the ‘swing instrument’, so to speak, and I’ll focus on it from here on.

What are my reasons for favouring limiting immigration to limit our population growth? It’s mainly my concern about the damaging ecological effects of population growth, as much from a global perspective as from a local Australian perspective. But this concern is augmented by my belief that economic growth (ie increase in material standard of living, as conventionally measured by the real growth in GDP per person) does nothing to increase subjective wellbeing (happiness) in developed countries. If so, why pay a social or environmental price to pursue it? But this isn’t true for developing countries, which is why I believe the rich countries need to limit both their population growth and their growth in GDP per person, to leave more ecological space for the understandable material aspirations of the poor countries. All this is discussed in my new book, The Happy Economist, which will be out in August.

OK, let’s get down to it: what’s the relationship between population growth and economic growth? This needs to be unpeeled like an onion. First, it’s clear that if you have a growing population - more people producing and consuming goods and services - you’ll get a bigger economy. But in narrow economic terms, what’s so good about having a bigger economy? Well, just about all business people, politicians and even economists think it sounds pretty nice. Business people like it simply because it gives them a bigger market to sell to and profit from - a much easier way to grow your business than trying to pinch market share from your competitors. To take an obvious example, the home-building industry wants to boost the demand for new houses. What business wants the politicians generally want, and they probably also think that in a growing economy voters are likely to be more content with the way things are going. As for economists, I think many of them are so conditioned to believe in growth that they’ve long ago stopped inquiring into the whys and wherefores.

But now the second layer of the onion. For a rigorous economic analysis it’s not good enough to simply assume that bigger is better. Why exactly is it better? The conventional answer is that bigger is better if it brings us a higher material standard of living - if it makes us more prosperous. But for this to happen - not necessarily for each individual, but on average, and for the community as a whole - the economy must grow faster than the population grows ie there must be an increase in real GDP per person.

But there’s a third layer: even if increased population does lead to higher GDP per person, who shares in that increase? Conventional economics is about self-interest, so for immigration to be justified economically it has to be shown that the pre-existing population benefits from the decision to increase the population. If instead all the benefit went to the immigrants, then the immigration program would be merely an act of charity.

So, from a narrow, strictly economic perspective, those are the questions to be answered when asking what the relationship is between economic growth and population growth: does population growth lead to higher income per person and, even if it does, do the people who agreed to let in more immigrants gain from that action?

The most recent official attempt to answer those questions came in a report prepared by the Productivity Commission in 2006, Economic Impacts of Migration and Population Growth. Now, the Productivity Commission is a body of impeccable credentials in economic orthodoxy, it’s one of the leading advocates for economic growth and you’d expect it to be very favourably disposed to the belief that immigration makes us better off materially. Which makes its findings all the more significant.

It sought to answer these questions the way economists do, by commissioning some economic modelling. Such models are built on a host of simplifying assumptions, they are driven by the modellers’ beliefs about how the economy works, and so their findings should be viewed with caution. The key assumptions driving the results need to examined, and the whole exercise can be subject to a lot of critical scrutiny. The proposition the PC modelled was the effect of a 50 pc increase in the level of skilled migration over the 20 years to 2024-25. It found that this did cause real GDP to be 4.6 per cent bigger than otherwise in 20 years time. And, yes, this did lead to an increase in real income per person, but the increase was pathetically small: 20 years later real income per person would be 0.7 per cent higher, or $380 a year. The PC found that ‘the distribution of these benefits varies across the population, with gains mostly accrued to the skilled migrants and capital owners. The incomes of existing resident workers grow more slowly than would otherwise be the case’.

The PC concludes that ‘factors other than migration and population growth are more important to growth in productivity and living standards’. Indeed, growth in income per person from technological progress and other sources of productivity growth, and long-term demographic changes, could be expected to be about 1.5 pc per year, or more than $14,000 a year by 2024-25.

So that’s an end point of $380 a year from immigration versus $14,000 a year from technological advance. On this evidence, a rational economic rationalist would have little enthusiasm for population growth. From my perspective, it leaves me confident my opposition to immigration-fed population growth on ecological grounds would not come at any great cost in terms of our material standard of living (or our happiness, for that matter).

But let’s look at why the PC’s modelling exercise came up with conclusions so at variance with what almost all business people, politicians and economists would have expected. It’s because the effects of immigration on the economy are complex, with some positive and some negative, so you have to try to determine the net balance, and the two pretty much cancel each other out. (PC2006report, from p115)

The first positive effect on GDP per person is that immigration leads to an increase in the proportion of the population that’s in the workforce producing things. The second positive effect on GDP per person from an increase in skilled migration is that the workforce is now a little more highly skilled on average, making its production more valuable. The third positive effect is that, eventually, consumer prices don’t rise as much as they would have, which increases incomes in real terms.

But offsetting those three positive effects - according to the PC’s very conventional analysis - are three negative effects. The first is that when the country suddenly gets more workers, those workers have to be supplied with additional physical capital (machines) to work with. That is, immigration leads to a need for ‘capital widening’. If the extra equipment isn’t forthcoming, we suffer a problem called ‘capital dilution’ - the amount of capital available per worker falls, which means the economy’s ratio of capital to labour falls, which means the productivity of labour falls. To the extent this happens, real income per person falls.

The second negative effect arises from the likelihood that a far bit of the extra physical capital our businesses need to avoid capital dilution will end up being supplied by foreign investors. The return that has to be paid to these foreign investors - in interest and dividends - represents a loss of income to Australian residents. So immigration will have the effect of adding to our current account deficit and foreign debt. The third negative comes from the model’s assumption that the bigger economy involves more exports and more imports, but while the prices we pay for those imports are unaffected, to sell more exports we have to accept slightly lower prices, meaning a deterioration in our terms of trade, which reduces our real national income.

That’s all very technical and hard to understand, and based on all the assumptions of the neoclassical model, many of which are wrong or misleading. For instance, I doubt that it takes sufficient account of the effect of the extra pressures migration creates for the public sector: the extra public infrastructure needed to meet the needs of the bigger population and the greater demands on the budget for services provided to immigrants and their families. This implies a need for higher taxation - paid by the original residents, not just the immigrants. And any delay or foul-up in providing the extra housing, roads, public transport, utilities, schools and hospitals etc could have significant negative effects on road congestion and other aspects of our amenity.

Even more significant, conventional economic analysis abstracts from the effect of economic activity on the natural environment, essentially assuming the environment to be a free good. Only when specific effort is made to ‘internalise’ environmental externalities - such as through an emissions trading scheme - do they enter into the model’s calculations. So these modelling results would take no account of the increased environmental costs generated by immigration-fed population growth: the increased emissions of greenhouse gases, the greater pressures on water, land quality, fish stocks and the destruction of species. All these very real costs - which eventually would feedback disastrously into GDP - are ignored in conventional analysis.

Now let’s take a different tack. When you ask why we in the developed countries should continue pursuing economic growth when the evidence says it does nothing to increase our subjective wellbeing, the best answer you get back is that we need continued economic growth to create the additional jobs needed to cope with a growing population. That is, if the population’s growing the economy needs to grow or we end up with ever-rising unemployment. This is a strong argument, but it loses its force in our world of an ageing population and a fertility rate that’s below the replacement rate of 2.1 babies per woman.

But in the present population debate the argument coming from the pro-growth side is the reverse: rather than arguing we need economic growth to cope with population growth, people such as the prominent demographer Professor Peter McDonald of ANU are arguing we need population growth to keep up with economic growth. The economy is growing strongly as we seek to exploit the super-high prices China and the world are willing to pay for our coal and iron ore. This growth is increasing employers’ demand for labour at a time when the unemployment rate is low and we’re close to full employment. High immigration is filling that demand, as well as helping to supply the growing labour needs of the mining states without them having to bid their wages up to persuade workers in other states to move to the backblocks of Western Australia and Queensland. In other words, if the economy’s demand for labour is outstripping the local population’s ability to supply that demand, but the government were to decline to allow more workers into Australia, the result would be a wage explosion as employers sought to attract the workers they need by bidding them away from other employers, which would soon lead to rapid inflation - which the Reserve Bank would respond to by greatly increasing interest rates so as to avoid inflation and trying to keep the economy comatose.

So McDonald’s argument is: the government doesn’t control the level of immigration, the economy does. Over the years the rate of immigration has gone up and down, and you can see a strong correlation with the ups and downs of the business cycle. More people come (and are let in) when the economy’s booming; fewer people come (or are wanted) when the economy’s in a slump.

It’s good to be reminded that economic growth is essentially endogenous. Governments use their fiscal and monetary policies to smooth the rate of growth, not to cause it. The micro-economic policies they pursue can encourage or discourage growth to some degree. But, fundamentally, the economy grows because businesses in free markets are always seeking out new ways to make a quid.

All this says that, as the economy is presently configured, it’s difficult for governments that have long courted economic growth to refuse to provide to the economy the immigrant labour it needs to avoid serious overheating.

But to acknowledge this difficulty is not to detract from my earlier point: all of this argument has proceeded on the conventional assumption that the environmental consequences of our economic actions can be safely ignored, to be thought about another day. So if our economy is presently configured in such a way that we can’t keep it functioning stably without doing additional damage to our natural environment - without exceeding the land’s carrying capacity - then the economy needs to be re-configured to put it onto a basis that’s ecologically sustainable. If it’s presently working on a basis that’s unsustainable then, by definition, things can’t continue the way they have been.

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