If there's no 'price gouging' how come interest rates are so high?

The nation’s economists have a dirty little secret. They all believe that what the punters denigrate as “price gouging” is actually a good thing, part of the mechanism by which a market economy returns to “equilibrium” (balance) after it’s been hit by an inflationary shock.

But they have a visceral hatred of terms such as “price gouging” and “profiteering”, and are always producing graphs and calculations purporting to prove that the recent surge in inflation – the worst in about 40 years – has produced no increase in company profits.

What they don’t seem to have noticed, however – or maybe are hoping none of us have noticed – is that you can’t argue that demand has been growing stronger than supply and so causing price increases, thus justifying using higher interest rates to slow down demand, and at the same time claim there’s no evidence that profits have risen.

Sorry, guys. You can’t have it both ways. If you claim there’s been no noticeable rise in profits, you’re contradicting the Reserve Bank’s main justification for its 13 increases in the official interest rate since May 2022. (Which is funny, considering the Reserve has been prominent among those seeking to deny that profits have risen.)

That main justification has been that much of the worsening in the rate of price increases has been caused by “excessive demand”, thus necessitating higher interest rates to discourage us from spending so much.

But how exactly does excessive demand lead to higher prices? It’s simple. When there are more people wanting to buy my product than I and my suppliers can keep up with, I could leave the price I’m charging unchanged, in which case it won’t be long before my shelves are empty, and I have nothing to sell.

That’s not the way it works in practice, however, nor the way it works in economic theory. I take advantage of strong demand to raise the price at which I’m selling the item. Why do I do this? Because, like all business people, I’m trying to maximise my profit.

The higher price means I won’t be selling my stock as fast as I was – so it will take longer for my shelves to empty – but I’ll still be better off.

Economists say that when demand exceeds supply, the stuff still available has to be rationed, one way or another. One way to ration supply is simply to keep selling at an unchanged price until everything is sold. After that, everyone who comes later misses out.

But when the seller raises their price, economists call this “rationing by [higher] price”. They believe this is always the better solution to the rationing problem because it does so in a way that uses the “market mechanism” to fix the problem.

The higher price encourages would-be buyers to reduce their demand – by wasting less of the product, or finding a cheaper substitute – while encouraging suppliers to produce more of the now-more-profitable product.

So because the higher price reduces demand while increasing the supply, the price mechanism causes the price of the item to fall back towards what it first was. Brilliant. Another win for market forces.

But this means a (possibly temporary) rise in prices is an essential part of the price mechanism. So a consequent rise in profits is also an inevitable part of the mechanism.

It’s gone out of fashion but, long ago, economists would say there were two causes of inflation: “cost-push” and “demand-pull”.

Sometimes firms raise their prices because they’re passing on the higher costs they’re paying for their inputs. At other times they’re raising their prices simply because the high demand for their product allows them to.

We now know from the work of behavioural economists that ordinary consumers accept it’s OK for businesses to raise their prices because of their higher costs. But they regard raising your prices just because shortages in supply let you get away with it as exploitative. (The classic example is charging more for umbrellas on rainy days.)

This dual, supply caused and demand-caused, explanation for inflation fits well with the Reserve’s analysis of the origins of the great surge in prices – in all the developed economies – in late 2021 and 2022.

Part of it was from disruptions to supply caused mainly by the COVID-19 pandemic, but also the Ukraine war, which pushed up the cost of building materials, various manufactured goods, shipping and oil and gas. But part of it was caused by the excessive stimulus applied to the economy by governments and central banks during the pandemic and its lockdowns, which had caused the demand for goods and services to run ahead of the economy’s ability to produce them.

Increasing interest rates can do nothing to increase supply, and the end of the lockdowns would see supply gradually return to normal, the Reserve reasoned. But higher rates could dampen the excess demand caused by all the extra government spending and rock-bottom interest rates that was applied to ensure the lockdowns didn’t lead to a lasting recession.

See how this analysis is undermined by claims there’s no sign of firms earning higher profits in the post-pandemic period? It implies that there’s no sign of excess demand, suggesting the surge in prices must have come only from supply disruptions and other cost increases.

In which case, the justification for maintaining high interest rates is greatly weakened. It implies that demand hasn’t been growing excessively and, rather than waiting for the supply problems to resolve themselves, we’re going to batter down demand to fit.

If so, that would be a very painful solution to a temporary problem. And, unlike the inflation problem we suffered in the 1970s, there’s no way this inflation surge can be blamed on excessive growth in wage costs.

Real wage growth had been weak long before the pandemic arrived. And in 2020, many workers were persuaded to skip an annual wage rise in the belief that we’d entered a lasting recession. As we subsequently discovered, government handouts to business meant many businesses sailed through the pandemic with few scratches.

Why so many economists want us to believe that, despite decades of increased market concentration – more industries dominated by just a few huge firms – and despite excessive monetary and budgetary stimulus, profits never increase, I’m blowed if I know.

Read more >>

Why the Reserve Bank thinks it's too soon to cut interest rates

By Millie Muroi, Economics Writer 

When the Reserve Bank’s second-in-command – recently appointed deputy governor Andrew Hauser – took shots at his closest observers this week, he ruffled plenty of feathers.

“It’s a world of winners and losers, gurus and charlatans, geniuses and buffoons,” he proclaimed. Then he wagged a finger at those confidently commentating from the sidelines on the direction of the economy. “It’s a dangerous game,” he warned.

We know economists – including those at the Reserve Bank – are notoriously bad at knowing exactly what we (and therefore the economy) will do. So, why was Hauser so mad at those confidently making their own calls?

Brash statements made by the media, government and economists have real-world consequences. People often rely on that information to make decisions, from taking out mortgages to negotiating wages.

“What about Phil Lowe?” you may ask. Didn’t the former RBA governor promise in 2021 that interest rates would not go up until 2024? Well, sort of. It was actually couched in caveats which many people glossed over.

The Reserve Bank generally treads carefully because the words of its bosses can shift behaviour: a hidden weapon beyond its interest rate-setting superpower.

RBA governor Michele Bullock often declares she is “not providing forward guidance” when fielding questions from journalists trying to get a steer on interest rates. But last week, she gave the closest thing to guidance in a while: people’s expectation for rate cuts in the next six months doesn’t align with the RBA board’s feeling, she said. At least, “not at the moment.”

In doing so, Bullock flexed the bank’s hidden bicep. She signalled for all of us to rein in our expectations of a rate cut and, she would have hoped, our inflation expectations.

This is important because what people believe can become reality. If we expect inflation to stay high, this belief can feed into the wages we ask for, and the prices businesses charge.

That’s not to say the Reserve Bank doesn’t believe its own thinking. The only medicine it can explicitly prescribe is the level of interest rates, but the central bank busies itself with a lot of data gathering, discussions and number crunching to diagnose the state of the economy.

Core to the Reserve’s thinking is its observation that, collectively, we are consuming more than we can produce for an extended period of time. Sure, young people and mortgage holders have been tightening their belts as housing costs surge. But that’s been more than offset by older, affluent Australians splurging on things such as travel, by population growth and by government spending.

Now, the government has bones to pick with any suggestion that its spending is contributing to inflation. And Government Services Minister Bill Shorten this week trashed RBA chief economist Sarah Hunter’s assessment that the economy is “running a little bit too hot”.

However, it is important to note Hunter’s view isn’t necessarily that Australians are doing too well, or that the economy is bubbling along. It’s more a reflection of the limited spare capacity we have to cater for the spending – however little or much of it we may be doing.

We’re spending “too much” mostly by comparison to the limited resources we have to keep up with it: the people making our coffee in the morning and machines they use to brew it for us, for example.

Unless we become more productive, making more with the things we already have, the more we strain people and machines to meet our demands, and the pricier things will be to produce.

Productivity is especially difficult to improve for sectors such as hospitality, which rely heavily on people rather than machines (there’s only so many ways your barista can brew a coffee faster and better). And it’s why services inflation is proving so much more stubborn than goods inflation.

How does the Reserve Bank know how much spare capacity we have (and therefore how much pressure we might expect on prices)? It looks at something called the output gap: the difference between how much we’re producing and how much we could produce without putting too much pressure on prices.

Heaven for the Reserve Bank would be an output gap of zero. Any lower means we’re not using our resources as intensively as we could – including people who want to work, but can’t find jobs, or machines sitting idle.

Any higher, and we’re using our resources too intensively. This can be OK for a short period, but as workers demand higher wages, machines are run into the ground and businesses compete for a shrinking pool of resources, prices rise. For the past few years, this is the state the Reserve Bank thinks our economy has been in.

Measuring the output gap is tricky. We can’t really see it, and our capacity can change over time as our population changes, or we find better ways to do things. So, how does the RBA measure it?

How much the economy is producing is measured through statistics such as Gross Domestic Product. The trickier task is pinning down how much the economy could produce without adding to inflation. To do this, the Reserve Bank uses economic models which spit out results based on things such as what’s happened in the past and the data plugged into them: relatively straightforward numbers such as population, as well as educated assumptions about other factors influencing the economy.

The bank also asks businesses about their capacity usage through surveys and by chatting with them through its liaison program. Then, there’s also the inflation figure itself.

While the output gap is just one gauge, it is given considerable weight in the Reserve Bank’s decisions. So far, the gap is narrowing, the bank says, but it’s likely we’re still pushing our resources past the ideal level to pull inflation back into line.

There’s not much the central bank can do to increase potential output, or capacity, in the economy, which is why it is instead focusing on weakening our demand, or spending.

While a rate cut now would be like an iron infusion for an anaemic economy, help preserve jobs, and bring mortgage holders relief, the bank is clearly on the warpath against its public enemy number one: inflation.

Keep in mind, though, no one is perfect. The Reserve Bank is careful to stress that the output gap, like most of its other measures, is “subject to considerable uncertainty.”

Read more >>

One reason for our inflation problem: weak merger law

Nothing excites the business section of this august organ more than news of another merger between two public companies. “Merger” is the polite word for it; usually the more accurate word is “takeover”.

So, is the dominant firm offering a good price for the firm being acquired? And should the shareholders in the dominant firm be pleased or worried about the deal? Will it benefit them, or just the company executives who organised it? A bigger company equals higher salaries and bonuses, no?

The financial press tends to regard takeovers as all good fun. Part of the thrills and spills or living and investing in a capitalist economy. But such mergers change the shape of the economy that provides us with our living. Do they make the economy better or worse?

According to the Albanese government’s Assistant Minister for Competition Dr Andrew Leigh, a former economics professor, some mergers improve the economy, whereas some worsen it.

As he explained in a speech this week, mergers are part of the market mechanism that allows financial capital to go where it’s most needed and will do most good to the consumers, workers and savers who make up an economy.

Most mergers are a healthy way for firms to achieve economies of scale and scope, and to access new resources, technology and expertise, Leigh says.

But mergers can do serious economic harm when firms are motivated by a desire to squeeze competitors out of the market and so capture a larger share of the particular market.

So “the small number of proposed mergers that raise competition concerns warrant close scrutiny” to see whether they should be allowed to proceed, he says.

The point is that, according to economic theory, the main thing ensuring ordinary people benefit from living and working in a capitalist economy is strong competition between the profit-making businesses providing our goods and services, which limits their ability to charge excessive prices and make excessive profits.

Competition obliges businesses to pass on to customers much of the savings they make from using improved technology to increase their economies of scale, while preserving the quality of service provided to their customers.

Similarly, competition between a reasonable number of alternative employers is needed to ensure their workers are fairly paid.

This is why laws controlling mergers are one of the main pillars of policy to keep competition between firms effective, along with prohibitions on the forming of cartels and other collusion between supposedly rival firms, and the misuse of “market power” – the power to keep prices above the competitive level.

Leigh says merger law is unique among those pillars because it’s the preventative medicine of competition law. While the other pillars deal with anticompetitive practices that are already being used, it deals with the likely effect of future anticompetitive actions the merger could make possible.

Fine. Trouble is, reformers have been batting for about 50 years to get effective restrictions on the ability of Australian companies to proceed with mergers designed to limit competition and enjoy excessive pricing power.

Leigh notes that a less-competitive market can add to the cost of doing business, and reduce the incentives and opportunities to invest, grow and innovate. For consumers, a less competitive market leads to higher prices, less choice, and lower growth in wages.

Big companies have resisted previous reforms – sometimes as represented by the (big) Business Council – sometimes, when Labor’s been in power, by big unions in bed with their big employers.

But now the Albanese government is making another attempt to get decent control over mergers that are expected to worsen competition.

And not before time. The challenge in Australia is to name more than a handful of industries not dominated by a few big firms.

Academic research Leigh has been associated with has shown that monopoly power worsens inequality by transferring resources from consumers to shareholders. He found evidence that market concentration – a few firms with a big share of the market – had worsened.

As well, profit margins had worsened and “monopsony hiring power” – few employers in an industry – was a problem in many industries.

After the Albanese government’s election in 2022, Treasurer Jim Chalmers and Leigh set up a Competition Taskforce within the Treasury focused on advising the government on actionable reforms to create a more dynamic and productive economy.

The taskforce’s top priority was to reform our merger laws. Consultations with industries said our piecemeal merger process was unfit for a modern economy and lagged best practice in other countries.

We were one of only three developed countries with a system of notifying proposed mergers that was merely voluntary. The Australian Competition and Consumer Commission (ACCC) complained about inadequate notification of proposed mergers, insufficient public information about the mergers, “a reactive, adversarial approach from some businesses” and limited opportunity to present evidence of likely economic harm arising from a particular merger.

In April this year, Chalmers and Leigh announced what they said were “the most significant reforms to merger rules in almost 50 years”. They would reduce three ways of reviewing merger proposals to a single, mandatory but streamlined path to approval, run by the ACCC.

For merger proposals above a monetary threshold or market-concentration threshold, this means those which would create, strengthen or entrench substantial market power will be identified and stopped. But those consistent with our national economic interest will be fast-tracked.

Challenges to the commission’s decisions will be the responsibility of an Australian Competition Tribunal, made up of a Federal Court judge, an economist and a business leader.

This should make it easier for the majority of mergers to be approved quickly, so the commission can focus on the minority that are a worry on competition grounds.

It’s the great number of our industries dominated by just a few firms that makes us especially susceptible to the inflation surge we’re still struggling to get back under control.

Read more >>

Cost-of-living crisis? Why only some of us are feeling the pinch

If you believe the opinion polls, we’re all groaning under the weight of the cost-of-living crisis. And Treasurer Jim Chalmers confirms we’ve all been “under the pump”. But it’s not that simple. Some of us are doing it a lot tougher than others. And some of us are actually ahead on the deal.

In any case, where did the living-cost crisis come from? That bit’s simple. The economy’s been on a rollercoaster for the past four and a half years. COVID and the lockdowns may seem a distant memory, but almost everything that’s happened in the economy since the end of 2019 has been the direct or indirect consequence of the pandemic.

The surge in consumer prices that began in early 2022 stemmed from a combination of temporary disruptions to supply caused by the pandemic, and excess demand for goods and services as people spent the money they’d earned but couldn’t spend during the lockdowns.

The tax cuts that began this month had been planned for six years, but Chalmers changed their intended shape radically to help people most affected by the cost of living. They mean that, by the end of this year, overall living standards should be just a little up on where they were five years ago.

Just as the media focus on bad news more than good news, so you and I focus more on what’s been happening to the cost of living than what’s been happening to our after-tax income. But it’s the difference between the two – our standard of living – that matters most.

Two economists at the Australian National University’s Centre for Social Policy Research, Associate Professor Ben Phillips and Professor Matthew Gray, have been crunching the numbers, and their results may surprise you.

They’ve examined the change in our standard of living since the end of 2019, and included a forecast up to the end of this year, to take account of the latest tax cuts and changes in the May budget.

Lumping all households together, they find that we did quite well in 2020 and 2021 as the Reserve Bank cut interest rates and governments spent billions on such things as the JobKeeper scheme and temporary doubling of JobSeeker unemployment benefits. But then living standards fell sharply in 2022 as consumer prices took off and housing costs rose. Living standards fell a little further last year, taking them to 0.6 per cent lower than they were before COVID arrived.

The authors estimate that, this year, the tax cuts and continuing pay rises will lift living standards to a princely 1.6 per cent above what they were in December 2019.

But those national averages conceal much variation. When the authors ranked all households by their disposable income, then divided them into five “quintiles”, the poorest 20 per cent are expected to end the five years with their living standard 3.5 per cent higher.

Huh? They did well partly because their pensions and benefits are indexed to inflation.

At the same time, the top 20 per cent of households are expected to be 2.7 per cent ahead. Why? Partly because they did well on their investments.

So it’s the middle 60 per cent of households that have been hit the hardest by the cost of living. The second lowest 20 per cent barely broke even, while the middle and upper-middle quintiles suffered a fall in their living standards.

But now we get to the pointy bit. Why did the middle do so much worse than the rest? Because that’s where you find most of the people with mortgages. Turns out all those households with mortgages are expected to see their living standards fall by 5.6 per cent over the five years to December 2024.

What about renters? Their living standards should rise by 2.9 per cent over the period. Huh? How could that be? It’s true that shortages of rental accommodation have caused rents to rise hugely this year and last. But much of that can be seen as catch-up for the lockdown-caused falls in rents in 2020 and 2021, and the small increases in 2022.

If you’re sitting down, I’ll tell you that the living standards of people who own their homes outright are expected to rise by … 8.5 per cent.

But here’s an even bigger shock: if you divide all the households by their main source of income, those in the “other” category – that is, not reliant on either wages or pensions – should see their standard of living rise by what the authors call “an astounding 15.8 per cent”.

Penny dropped yet? Yes, we’re talking about the group that always has its hand out for a handout to thank it for being too well-off to get the age pension: the self-described, so-called self-funded retirees.

But while you’re feeling sorry for all those poor souls (whose company I’ll be joining one day), spare a kick for the economists who, several decades ago, had the bright idea of using only interest rates to control inflation. They must have had a fairness bypass.

Read more >>

OECD’s message to our inflation warriors: calm down, she’ll be right

Last week a bunch of international public servants in Paris launched a rocket that landed in Sydney’s Martin Place, near the Reserve Bank’s head office and the centre of our financial markets. It carried a message we should already know. Australia has a big problem with real wages: they’re too low. In which case, why are you guys so anxious about continuing high inflation?

The Organisation for Economic Co-operation and Development’s annual Employment Outlook says Australia’s real wages in May this year are still 4.8 per cent lower than they were in December 2019, just before the pandemic.

This is one of the largest drops among OECD countries. It compares with real falls of 2 per cent in Germany and Japan, and 0.8 per cent in the United States. Real wages have risen by 2.4 per cent in Canada and 3.1 per cent in Britain.

The organisation observes that, “as real wages are [now] recovering some of the lost ground, profits are beginning to buffer some of the increase in labour costs. In many countries, there is room for profits to absorb further wage increases, especially as there are no signs of a price-wage spiral”.

Just so. But this isn’t something you’re allowed to say out loud in Martin Place. When the Australia Institute copied various overseas authorities in calculating the contribution that rising profits had made to our rising prices, it was dismissed by the Reserve Bank and the financial press.

Apparently, it’s OK for the Reserve to say it must increase interest rates because demand is growing faster than supply and adding to inflation, but it’s not OK to say that businesses have used the opportunity to raise their prices and this has increased their profits.

No, in the Reserve’s eyes, the problem with prices soaring way above its inflation target has never been greedy bosses, but always the risk of greedy workers using their industrial muscle to prevent their real wages from falling and thus causing a price-wage spiral that perpetuates high inflation.

It was a worry that anyone who knew anything about the changed power balance between employers and workers and their unions – anyone who wasn’t still living in the 1970s – could never have entertained.

For many years, the Reserve Bank benefited greatly from having a senior union official appointed to its board along with the many business people. But John Howard soon put a stop to that.

Since then, the Reserve has had to fall back on the primitive understanding of how labour markets work that you gain from a degree in neoclassical economics. Fortunately, since last year the board has included Iain Ross, former president of the Fair Work Commission.

The Reserve’s great sense of urgency in getting the inflation rate back down since it began raising interest rates in May 2022 has been driven by two worries about wages. First, when excessive monetary and budgetary stimulus caused the post-lockdown economy to boom while our borders were closed to imported labour, it worried that shortages of skilled and even unskilled labour would cause wages to leap as employers sought to bid workers away from other firms.

Although job vacancies more than doubled, reaching a peak in May 2022, annual wage growth had risen no higher than 4.2 per cent in December last year, even though consumer price inflation had peaked at 7.8 per cent a year earlier.

So, though no one’s bothered to mention it, our first period of acute labour shortages in decades hardly caused a ripple. It’s probably fair to say, however, that had the shortages not occurred, wages would have fallen even further behind prices than they did.

The Reserve’s second reason for feeling a sense of urgency in getting inflation back down to the target range is its fear that, should we leave it too long, inflation expectations may rise, causing actual inflation to move to a permanently higher level.

Indeed, the signs that our return to target will be slow have been used by the Reserve’s urgers in the financial markets to call for another rate rise or two. Apparently, every week’s delay in getting inflation down could see inflation expectations jump.

But this is mere pop psychology. Even if the nation’s workers and unions were to expect that inflation will stay high, they lack the industrial muscle to raise wage rates accordingly. If you didn’t already know that, our outsized fall in real wages should be all the proof you need.

Read more >>

It's slowing the spin doctors' spin that keeps me busy

Do you remember former prime minister John Howard’s ringing declaration that “we will decide who comes to this country and the circumstances in which they come”? It played a big part in helping him win the 2001 federal election. But it’s only true in part.

The job of economic commentators like me is supposed to be telling people about what’s happening in the economy and adding to readers’ understanding of how the economy works.

But the more our politicians rely on spin doctors to manipulate the media and give voters a version of the truth designed always to portray the boss in the most favourable light, the more time I have to spend making sure our readers aren’t being misled by some pollie’s silken words.

These days, I even have to make sure our readers aren’t being led astray by the economics profession. For the first time in many years, I’ve found myself explaining to critical academic economists that I’m a member of the journos’ union, not the economists’ union.

Like many professions, economists are hugely defensive. And they like to imagine my job is to help defend the profession against its many critics. Sorry, I’m one of the critics.

My job is to advise this masthead’s readers on how much of what economists say they should believe, and how much they should question.

It’s not that economists are deliberately misleading, more that they like to skirt around the parts of their belief system that ordinary people find hard to swallow.

And then there’s the increasing tendency for news outlets to pick sides between the two big parties, and adjust their reporting accordingly. My job is to live up this masthead’s motto: Independent. Always.

So, back to Howard’s heroic pronouncement. It’s certainly true that “we” – the federal government – decide the circumstances in which people may come to Australia. If you turn up without a visa, you’ll be turned away no matter how desperate your circumstances. If you come by boat, your chances of being let in are low.

But if you come by plane, with a visa that says you’ll be studying something at some dodgy private college when, in truth, you’re just after a job in a rich country, in you come. If we’ve known about this dodge, it’s only in the past few weeks that we’ve decided to stop it.

No, the problem is, if you take Howard’s defiant statement to mean that we control how many people come to this country, then that’s not true. We decide the kinds of people we’ll accept, but not how many.

There are no caps because, for many years, both parties have believed in taking as many suitable immigrants as possible. It’s just because the post-COVID surge in immigration – particularly overseas students – has coincided with the coming federal election that the pollies are suddenly talking about limiting student visas.

But remember, the politicians have form. Knowing many voters have reservations about immigration, they talk tough on immigration during election campaigns, but go soft once our attention has moved on, and it’s all got too hard.

It’s a similar thing with Anthony Albanese’s Future Made in Australia plan. Polling shows it’s been hugely popular with voters. But that’s because they’ve been misled by a clever slogan. It was designed to imply a return to the days when we tried to make for ourselves all the manufactured goods we needed.

But, as I’ve written, deep in last month’s budget papers was the news that we’d be doing a bit of that, but not much. It’s just a great slogan.

On another matter, have you noticed Treasurer Jim Chalmers’ dissembling on how he feels our pain from the cost-of-living crisis, which is why he’s trying so hard to get inflation down?

What he doesn’t want us thinking about is that, at this stage, most of the pain people are feeling is coming not from higher prices, but from the Reserve Bank’s 4.25 percentage-point increase in interest rates.

Get it? The pain’s coming from the cure, not the disease. The rise in interest rates has been brought about by the independent central bank, not the elected government, of course. But when Chalmers boasts about achieving two successive years of budget surplus, he’s hoping you won’t realise that those surpluses are adding to the pain households are suffering, particularly from the increase in bracket creep.

And, while I’m at it, many people object to businesses raising their prices simply because they can, not because their costs have increased. This they refer to disapprovingly as “gouging”.

But few economists would use that word. Why not? Because they believe it’s right and proper for businesses to charge as much as they can get away with.

Why? Because they think it’s part of the way that market forces automatically correct a situation where the demand for some item exceeds its supply. In textbooks, it’s called “rationing by price”.

Rather than the seller allowing themselves to run out of an item, they sell what’s left to the highest bidders. What could be better than that?

Read more >>

Treasury tells all: how the housing market is so stuffed up

Would you believe that our ever-rising house prices are a sign there’s something badly wrong with our housing market? Would you believe our housing arrangements are worse than in the other rich countries?

Well, I would when that’s what Treasury is admitting in the annual sermon it tacks onto the budget papers. This year it’s about meeting our housing “challenge”.

In a well-functioning economy, its industries can respond to the increase in demand for their good or service by increasing their supply without much delay. Of course, it takes a lot longer to build a new house or apartment than it does to churn out more ice-creams or haircuts.

But, even so, our housing industry has been too slow to respond to the increased demand for housing. This comes from our rising population which, thanks to continuing high levels of immigration, has grown faster than most of the other rich countries.

Figures from the Organisation for Economic Co-operation and Development, a group of mainly advanced economies, show that our number of dwellings per 1000 people increased only from 403 to 420 between 2011 and 2022. This compared poorly with most other countries.

In 2011, our level of housing supply was just 92 per cent of the OECD average. And by 2022 it had fallen to 90 per cent. This was behind countries such as Canada, the United States and England.

Our completions of new private dwellings reached a peak of more than 200,000 a year in 2018-19 but have since fallen to about 160,000 a year. This has left us with an acute shortage of properties available to buy or rent.

Nationwide, the number of homes being offered for sale has fallen since 2015, while the number offered for rent has been falling since early 2020.

Speaking of renting, Treasury says the rental market is considered to be in balance – meaning renters have little trouble finding a place and landlords have little trouble finding a tenant – when the vacancy rate is about 3 per cent. In cities such as Sydney and Melbourne it’s now down to about 0.5 per cent. Ouch.

Not surprisingly, when demand grows faster than supply can keep up with, prices rise. The rise in the cost of newly built homes, and the cost of renting, have contributed significantly to the general cost-of-living crisis.

So, why has our housing industry become so slow to respond to increased demand? Treasury says the causes are “multifaceted, complex and affect all stages of the housing construction process, including all levels of government and industry”.

One way to improve the market’s response to greater demand is to accelerate the construction process. But Treasury says that completion times for apartments, townhouses and detached houses actually worsened by 39 per cent, 34 per cent and 42 per cent respectively over the 10 years to June 2023.

Calculations (or, if you want to sound more scientific, “modelling”) by a federal government agency says that, over the next six years, the nation’s existing unmet demand will never be satisfied unless completion times are speeded up. In six years’ time, we’ll still have a backlog of about 39,000 dwellings.

Treasury says the expectation that churning out homes faster will help to lower house prices is supported by empirical research. One study found that those OECD countries that built more housing over the 15 years to 2015 experienced lower real growth in house prices.

Another study showed that adding an extra 50,000 homes a year for a decade could reduce house prices by up to 20 per cent.

So, what can be done to increase the housing industry’s annual output? Treasury says planning and zoning restrictions can limit the speed at which land is made available.

Delays in approving development applications by local councils can be excessive. I think councils and government departments are monopolists and, like all monopolists, they take advantage of the lack of competition.

Private sector monopolists whack up their prices and don’t worry about the quality of the service they provide. Public monopolists make you jump through hoops that aren’t strictly necessary, and they fix your problem in their own good time.

I wonder whether, over all these years, those outfits have ever had much pressure on them to lift their game. If that changed, I’m sure we could get more homes built per year.

Treasury says average times for the approval of development applications vary by state, with Victoria and NSW experiencing the longest waiting times early this month of 144 and 114 days, respectively.

It shouldn’t surprise you that Treasury wants housing to be delivered in well-located areas where the demand is greatest.

Dense development in the “missing middle” of major cities, where households can reside closer to jobs in areas with higher quality amenities and infrastructure, has been limited by planning and zoning restrictions and slow release of infill land, Treasury says.

Global supply constraints and price shocks on imported building materials associated with the pandemic have added to the cost of construction, driving up the price of newly built homes. Although prices aren’t rising as fast as they were, they haven’t fallen back.

Shortages of building labour have also increased the prices of newly built homes and slowed the pace of construction. The growth in non-dwelling construction activity has drawn labour away from home building. The productivity of labour in construction has not improved since the early 2000s.

The industry blames these shortages on the drop-off in rates of skilled migration during the pandemic. But I wonder if the deeper problem is that the former ready availability of imported labour tempted the industry to save money by failing to train as many apprentices as they should have.

So, what’s the Albanese government doing about this mess? It’s finally grasped the nettle and is spending big – $32 billion, including $6 billion in this month’s budget – to “address historical underinvest in the housing system” and build 1.2 million new, well-located homes. We’ll see how they go.

Read more >>

Budget's message: maybe we'll pull off the softest of soft landings

When normal people think about the economy, most think about the trouble they’re having with the cost of living. But when economists think about it, what surprises them is how well the economy’s travelling.

It’s been going through huge ups and downs since COVID arrived in early 2020. By 2022, it was booming and the rate of unemployment had fallen to 3.5 per cent, its lowest in almost 50 years. Meaning we’d returned to full employment for the first time in five decades.

Trouble was, like the other rich economies, prices had begun shooting up. The annual rate of inflation reached a peak of almost 8 per cent by the end of 2022.

The managers of the economy know what to do when the economy’s growing too fast and inflation’s too high. The central bank increases interest rates to squeeze households’ cash flows and discourage them from spending so much.

The Reserve Bank started raising the official “cash” interest rate in May 2022, just before the federal election. It kept on raising rates and, by November last year, had increased the cash rate 13 times, taking it from 0.1 per cent to 4.35 per cent.

While this was happening, Treasurer Jim Chalmers was using his budget – known to economists as “fiscal policy” – to help the Reserve’s “monetary policy” to increase the squeeze on households’ own budgets, reducing their demand for goods and services.

Why? Because, when businesses’ sales are booming, they take the chance to whack up their prices. When their sales aren’t all that brisk, they’re much less keen to try it on.

The government’s tax collections have been growing strongly because many more people had jobs, or moved from part-time to full-time, and because higher inflation meant workers were getting bigger pay rises.

As well, iron ore prices stayed high, meaning our mining companies paid more tax than expected.

Chalmers tried hard to “bank” – avoid spending – all the extra revenue. So, whereas his budget ran a deficit of $32 billion in the year to June 2022, in the following year it switched to a surplus of $22 billion, and in the year that ends next month, 2023-24, he’s expecting another surplus, this time of $9 billion.

So, for the last two years, Chalmers’ budget has been taking more money out of the economy in taxes than it’s been putting back in government spending, thus making it harder for households to keep spending.

Guess what? It’s working. Total spending by consumers hardly increased over the year to December 2023. And the rate of inflation has fallen to 3.6 per cent in the year to March. That’s getting a lot closer to the Reserve’s target of 2 to 3 per cent.

The Reserve’s rate rises have been the biggest and fastest we’ve seen. Wages haven’t risen as fast as prices have and, largely by coincidence, a shortage of rental accommodation has allowed big increases in rents.

And on top of all that you’ve got the budget’s switch from deficits to surpluses. Much of this has been caused by bracket creep – wage rises causing workers to pay a higher average rate of income tax, often because they’ve been pushed into a higher tax bracket.

Bracket creep is usually portrayed as a bad thing, but economists call it “fiscal drag” and think of it as good. It acts as one of the budget’s main “automatic stabilisers”, helping to slow the economy down when it’s growing too quickly and causing higher inflation.

The Reserve keeps saying it wants to get inflation back under control without causing a recession. But put together all these factors squeezing household budgets, and you see why people like me have worried that we might end up with a hard landing.

Which brings us to this week’s budget. The big news is that in the coming financial year the budget is expected swing from this year’s surplus of $9 billion to a deficit of $28 billion.

This is a turnaround of more than $37 billion, equivalent to a big 1.3 per cent of annual gross domestic product. So, whereas for the past two financial years the “stance” of fiscal policy has been “contractionary” (acting to slow the economy), it will now be quite strongly “expansionary” (acting to speed it up).

Some people who should know better have taken this turnaround to have been caused by a massive increase in government spending. They’ve forgotten that by far the biggest cause is the stage 3 tax cuts, which will reduce tax collections by $23 billion a year.

The same people worry that this switch in policy will cause the economy to grow strongly, stop the inflation rate continuing to fall and maybe start it rising again. But I think they’ve forgotten how weak the economy is, how much downward pressure is still in the system, and how long it takes for a change in the stance of policy to turn the economy around.

Treasury’s forecasts say the economy (real GDP) will have grown by only 1.75 per cent in the financial year just ending, will speed up only a little in the coming year and not get back to average growth of about 2.5 per cent until 2026-27.

So, the rate of inflation will continue falling and should be back into the target range by this December. All this would mean that, from its low of 3.5 per cent – which had risen to 4.1 per cent by last month – the rate of unemployment is predicted to go no higher than 4.5 per cent.

That would be lower than the 5.2 per cent it was before the pandemic, and a world away from the peak of about 11 per cent in our last big recession, in the early 1990s.

So maybe, just maybe, we’ll have fixed inflation and achieved the softest of soft landings. Treasury’s forecasting record is far from perfect, to put it politely, but it is looking possible – provided we don’t do something stupid.

Read more >>

Let's stop using interest rates to throttle people with mortgages

What this country needs at a time like this is economists who can be objective, who’re willing to think outside the box, and who are disinterested – who think like they don’t have a dog in this fight.

On Friday, Reserve Bank governor Michele Bullock, with her lieutenants, made her first appearance as governor before the House of Reps economics committee.

See if you can find the logical flaw in this statement she made: “The [Reserve’s] board understands that the rise in interest rates has put additional pressure on the households that have mortgages. But the alternative of lower interest rates and high inflation for a prolonged period would be even worse for these households, as well as all the households without mortgages.”

Sorry, that’s just Bullock doing her Maggie TINA Thatcher impression, mindlessly repeating the assertion that “There Is No Alternative”. Nonsense. There are various alternatives, and if economists were doing their duty by the country, they’d be talking about them, evaluating them and proposing them.

What’s true is that the Reserve has no alternative to using interest rates to slow demand. Some economists can be forgiven for being too young to know that we didn’t always rely mainly on interest rates to fight inflation, just as we didn’t always allow the central bank to dominate the management of the economy.

These were policy changes we – and the rest of the rich world – made in the early 1980s because we thought they’d be an improvement. In principle, now we’re more aware of the drawbacks of giving the central bank dominion over macroeconomic management, there’s no reason we can’t decide to do something else.

In practice, however, don’t hold your breath waiting for the Reserve to advocate making it share its power with another authority. Nor expect the reform push to be led by economists working in industries such as banking and the financial markets, which benefit from their close relations with the central bank.

What those with eyes should have seen in recent years is that relying so heavily on an instrument as blunt as interest rates is both inequitable and inefficient. It squeezes the third of households with mortgages – or the even smaller proportion with big mortgages – while hitting the remaining two-thirds or more only indirectly.

It’s largely by chance that the Reserve’s need to jam on the demand brakes has coincided with the worst shortage of rental accommodation in ages, thereby spreading the squeeze to another third of households. Had this not happened, the Reserve would have needed to bash up home buyers even more brutally than it has.

Clearly, it would be both fairer – and thus more politically palatable – and more effective to use an instrument that directly affected a much higher proportion of households. This should mean the screws wouldn’t have to be tightened so much, another advantage.

One obvious alternative tool would be to temporarily move the rate of the goods and services tax up (or, at other times, down) a percentage point or two.

Another alternative, one I like, is to divide compulsory employer superannuation contributions into a part permanently set at 11 per cent, and a part that could be varied temporarily between plus several percentage points and minus several points.

This would leave workers less able to keep spending (or more able to spend), as the managers of demand required to stabilise both inflation and unemployment.

Its great attraction is that it involves the government temporarily fiddling with people’s ability to spend, without actually taking any money from them. Surely, this would be the least politically painful way to manage demand.

Experience with central-bank dominance has shown us one big advantage: the economic car has been driven markedly better when the brake and the accelerator are controlled by econocrats independent of the elected government.

But this simply means we’d have to set up an independent authority to control all the instruments of macro management, whether monetary or fiscal.

Not all our economists have been too stuck in the mud of orthodoxy to think these new thoughts. They were canvased by professors Ross Garnaut and David Vines in their submission to the Reserve Bank inquiry – which, predictably, was brushed aside by a panel of economists anxious to stay inside the box.

A century ago, Australians were proud of the way we showed the world better ways of doing things, such as the secret ballot and votes for women. These days, our economists are dedicated followers of international fashion.

This means the country that should be leading the way to better tools to manage demand will wait until it becomes fashionable overseas. Why should we be first? Because our unusual practice of having mainly variable-rate home loans means our use of the interest-rate tool bites a lot harder and faster, thus making our monetary policy a lot blunter than theirs.

Economists may not fret much about how badly some punters are hurting as the economic managers rapidly correct the consequences of their gross miscalculations – the Reserve played a big part in the excessive stimulus during the COVID lockdowns – but one day the politicians who carry the can politically for these miscalculations will revolt against the arrogance of their economic gurus.

Reserve Bank governors – and, in earlier times, Treasury secretaries – privately congratulate themselves for being the last backstop protecting the nation against inflation. When no one else cares, they do. When no one else will impose a cost of living crisis on spendthrift consumers, they will.

Don’t you believe it. If they cared as much as they think they do, they’d care a lot more about effective competition policy. But when the economists leading the Australian Competition and Consumer Commission – Allan Fels and later, Rod Sims – were battling to get more power to reject anticompetitive mergers, they got precious little support from their fellow economists.

While the (Big) Business Council was lobbying privately to retain the laxity, backed up on the other side by a few Labor-Party-powerful unions that had done sweetheart deals with their big employers, the Reserve and Treasury were missing in action.

The people at the bottom of the inflation cliff boast about the diligence of their ambulance service, while doing nothing to help the people at the top of the cliff trying to erect a better safety fence.

If you were looking for examples of oligopolies with pricing power, you could start with the big four banks. If you were looking for examples of “regulatory capture” – where the bureaucrats supposed to be regulating an industry in the public interest get sweet-talked into going easy – you could start with the Reserve and banking (with Treasury not far behind).

In the natural conflict between the goals of financial stability and effective competition, the Reserve long ago decided we’d worry about competition later.

But the more concentrated we allow our industries to become, the more often the Reserve will have to struggle to control inflation surges, and the harder it will need to bash home-buyers on the head.

Read more >>

You can (partly) blame cost-of-living crisis on greedy businesses

The nation’s economists and economist-run authorities such as the Reserve Bank have not covered themselves in glory in the present inflationary episode. They’ve shown a lack of intellectual rigor, an unwillingness to re-examine their long-held views, and a lack of compassion for the many ordinary families who, in the Reserve’s zeal to fix inflation the blunt way, have been squeezed till their pips squeak.

There’s nothing new about surges of inflation. Often in the past they’ve been caused by excessive wage growth, where economists have been free with their condemnation of greedy workers. But this one came at a time when wage growth was weak and barely keeping up with prices.

What economists in other countries wondered was whether, this time, excessive growth in profits might be part of the story. Separate research by the Organisation for Economic Co-operation and Development, the International Monetary Fund, the Bank for International Settlements, the European Commission, the European Central Bank, the US Federal Reserve and the Bank of England suggested there was some truth to the idea.

But if the Reserve or our Treasury shared that curiosity, there’s been little sign of it. Rather, when the Australia Institute replicated the European Central Bank’s methodology with Australian data and found profit growth did help explain our inflation rate, the Reserve sought to refute it with a dodgy graph, while Treasury dismissed it as “misleading” and “flawed”.

One leading economist who has been on the ball, however, is Professor Allan Fels, a former chair of the Australian Competition and Consumer Commission, whose experience of competition and pricing issues goes back to the year before I became a journalist.

In his report this week on price gouging and unfair pricing practices, commissioned by the Australian Council of Trade Unions, he concluded that “business pricing has added significantly to inflation in recent times”.

Fels says his report is “fully independent” of the ACTU, which did not try to influence him. Considering his authority in this area, I have no trouble believing it.

“ ‘Profit push’ or ‘sellers’ inflation’ has occurred against a background of high corporate concentration and is reflected in the surge of corporate profits and the rise in the profit share of gross domestic product,” he finds.

“Claims that the rise in profit share in Australia is explained by mining do not hold up. The profit share excluding mining has risen and [in any case,] energy and other prices associated with mining have been a very significant contributor to Australian inflation,” he says.

Fels says there has been much discussion about inflation and its causes – including monetary policy and fiscal policy, international factors, wages, supply chain disruption and war, but “hardly any discussion that looks at actual prices charged to consumers, the processes by which they are set, the profit margins and their possible contribution to inflation”.

His underlying message is that there are too many industries in Australia which are dominated by just a few huge companies – too many “oligopolies” – which limits competition and gives those companies the ability to influence the prices they can charge.

“Not only are many consumers overcharged continuously, but ‘profit push’ pricing has added significantly to inflation in recent times,” he says, nominating specifically supermarkets, banks, airlines and providers of electricity.

Fels says, “some of Australia’s largest businesses, often [those selling such necessities that customers aren’t much deterred by price rises], are maintaining or increasing margins in response to the global inflationary episode”.

He identifies eight “exploitative business pricing practices” – tricks – that enable the extraction of extra dollars from consumers in a way that wouldn’t be possible in markets that were competitive, properly informed, and that enabled overcharged customers to switch easily from one business to another.

First, “loyalty taxes” set initial prices low and then sharply increase them in later years when customers can’t easily detect, question, or renegotiate them, and where the “transaction costs” of changing to another firm are high. This trick can be found in banking, insurance, electricity and gas.

Second, “loyalty schemes” are often low-cost means of retaining and exploiting consumers by providing them with low-value rewards of dubious benefit.

Third, “drip pricing” occurs when firms advertise only part of a product’s price and reveal other costs as the customer continues through the purchasing process. This trick is spreading in relation to airlines, accommodation, entertainment, pre-paid phone charges, credit cards and other things.

Fourth, “excuse-flation” occurs when general inflation provides camouflage for businesses to raise prices without justification. This has been more prevalent recently. As the inflation rate starts falling, excessive inflation expectations and further cost increases can be built in to prices.

Fifth, “confusion pricing” involves confusing customers with myriad complex price structures and plans, making it difficult to compare prices and so dulling price competition. This is occurring increasingly in mobile phone plans and financial or maintenance service contracts.

Sixth, asymmetric or “rockets and feathers” pricing is a big deal now the rate of inflation is falling. When a firm’s costs rise, prices go up like a rocket; when its costs fall, prices drift down slowly like a feather.

Fels says this trick can be very profitable for businesses. The banks have long been guilty of this stunt, yet I can’t remember a Reserve Bank governor ever calling it out.

Seventh, “algorithmic pricing” is where firms use algorithms to change prices automatically in response to what their competitors are doing. Fels wonders whether this reduces price competition and is analogous to the way now-illegal cartel pricing worked.

Finally, “price discrimination” involves charging different customers different prices for the same product, according to what the firm deduces a particular customer is “willing to pay”. The less competition firms face, the easier it is for them to play this game.

That so few economists and econocrats have been willing to think about these issues doesn’t speak well of their profession’s integrity. If they won’t speak out about businesses’ failings, why should we trust what they do tell us?

Read more >>

Are the supermarket twins too keen to raise their prices?

The cost-of-living crisis has left many convinced the two big supermarket chains – known to some as Colesworth – have been “price gouging” – raising their prices without justification. “Gouging” is a rude, pejorative phrase that would never cross an economist’s lips (nor mine), but economic theory does say that, when an industry is dominated by just a few huge companies, this will give them the power to manipulate prices to their own advantage.

But anecdotes and even economic theory are one thing, hard evidence is another. And knowing what to do about it is a third. So it’s good that last Friday, Treasurer Jim Chalmers launched a full inquiry into supermarket prices by the Australian Competition and Consumer Commission. Chalmers said this was “about making our supermarkets as competitive as they can be so Australians get the best prices possible”.

The inquiry, which will take a year, will include an examination of online shopping, the effects of loyalty programs and how advances in technology are affecting competition.

The competition watchdog’s chair, Gina Cass-Gottlieb, said the commission will use its compulsory information-gathering powers to collect financial details from the supermarket giants.

The government has also commissioned a former Labor minister and economist, Dr Craig Emerson, to review the effectiveness of the “food and grocery code of conduct”, introduced in 2015 to stop the big supermarkets from using their buying power to extract unreasonably low prices from their suppliers, particularly farmers.

The code is voluntary and has no way of punishing bad behaviour, so hasn’t worked well. It’s drawn few complaints from suppliers, probably because they’re afraid of retaliation by Colesworth. Only if it’s made compulsory and given teeth is it likely to improve the farmers’ lot.

Our groceries market is one of the most concentrated in the developed world. Woolworths has 37 per cent of the market and Coles has 28 per cent, leaving Aldi with 10 per cent and Metcash (wholesaler to IGA stores) with 7 per cent. So our two giants’ combined share of 65 per cent compares with Britain’s top two’s share of 43 per cent. In the United States, the four largest chains make up just 34 per cent of the market.

While we wait for the competition watchdog’s report, what do we know about the chains’ behaviour?

The report of an unofficial inquiry into price gouging and unfair pricing practices, commissioned by the ACTU from a former competition commission chair, Professor Allan Fels, will be published on Wednesday.

But we know from a letter Fels sent to Chalmers last month what it will say about supermarkets. Fels said the inquiry had been inundated with concerns from experts and regular Australians alike on the prices set by the chains.

Fels found that neither Coles nor Woolworths suffered declines in profit during the pandemic because their services had been deemed essential. Since then, however, both have increased their profit margins, thanks to weak competition and their ability to delay passing on any cost reductions.

Fels noted that high prices, including co-ordinated price increases between the two, aren’t actually prohibited by competition law, except where there is unlawful communication or agreement between the firms. (Which, of course, doesn’t prohibit tacit collusion.)

Duopolies have a mutual incentive not to decrease prices where possible, Fels said, particularly on those goods whose prices are closely watched by customers.

“There has not been a price war between the major supermarkets in some years,” he said. This contrasts with the British experience, where Tesco and Sainsbury’s entered an aggressive price war with Aldi.

Here, the entrance of Aldi has been helped by outlawing the ability of the big two to do deals with shopping centre owners preventing rival supermarkets from setting up. Fels said he shared the watchdog’s concern about the big two’s ability to limit competition by engaging in “land banking” – hoarding supermarket sites, so rival companies can’t get a foothold.

Fels worries also about the giants playing “rockets and feathers”. When their costs rise, their prices go up like a rocket, but when their costs fall, their prices drift slowly down like a feather.

Fels found that, as prices have increased, consumers had noticed again and again that once-normal prices were being advertised back to shoppers as “special”.

He quoted one submission to his inquiry asserting that, until August 2022, Coles and Woolies sold a 200-gram jar of Timms coffee for $8. Then Coles increased the shelf price to $12.70 before, a couple of weeks later, reducing the price to $10.70 with a tag saying “was $12.70 per bottle, now ‘down, down!’.”

Another submission asserted that Devondale cheese had gone from $5 to $10 in recent months, but had then been on “special” for $10.

Cass-Gottlieb has said the commission was “carefully looking” at claims that some discounts amounted to deceptive conduct. She also said it was concerned by “was, now pricing”, which might be outlawed.

If all the pain of the cost-of-living crisis at last prompts this government to get tough with the game-playing supermarkets, it will be some consolation.

Read more >>

With luck, we’ll escape recession next year, but it will feel like one

What we’ve come to call the “cost-of-living crisis” has made this an unusually tough year for many people as they struggle to make ends meet. It’s likely to get worse rather than better next year. Which won’t help Anthony Albanese’s chances of being comfortably returned to government in early 2025.

Everyone hates rapidly rising prices and demands the government do something. But I’m not sure everyone understands the paradoxical nature of the usual ways central banks and governments go about fixing the problem. They make it worse to make it make better.

In a market economy, when our demand for goods and services exceeds the economy’s ability to supply them, businesses solve the problem by putting up their prices. The economic managers then seek to weaken our demand by squeezing households’ finances so that they can’t spend as much.

As our spending weakens, firms are less able to keep raising their prices without losing sales.

The main way the Reserve Bank puts the squeeze on household spending is by engineering a rise in mortgage interest payments, leaving people with less money to spend on everything else.

A shortage of rental housing has allowed landlords to make big rent increases. Employers have helped the squeeze by ensuring they raise wages by less than they’ve raised their prices. And Treasurer Jim Chalmers has helped by allowing bracket creep to take a bigger tax bite out of wage increases.

All this is why so many people have been feeling the financial heat this year. But even if there are no more interest rate rises to come, the existing pressures are still working their way through the economy, with little sign of relief.

Consumer prices rose by 7.8 per cent over the year to last December, but the annual rate of increase slowed to 5.4 per cent in September. That’s still well above the Reserve’s target of 2 per cent to 3 per cent.

If the Reserve has accidentally hit the economy harder than intended, we could slip into recession next year, causing a big jump in the number of people out of a job, and thus hitting them much harder.

But with any luck, it won’t come to that. And the crazy-lazy way the media define recession – a fall in real gross domestic product in two successive quarters – means that growth in the population may conceal the hip-pocket pain many people are feeling.

Consider the case of someone on the very modest wage of $45,000 a year in September 2021. If their wage rose in line with the wage price index, it would have risen by $3300 to $48,300 in September this year.

However, bracket creep, plus the discontinuation of the low and middle income tax offset, raised the average rate of income tax they pay from 9.8¢ in the dollar to 14.2¢. So their tax bill would have grown by $2460.

Now allow for the rise in consumer prices over the two years, and the purchasing power of their disposable income has fallen by about $5290, meaning their “real” disposable income is $4450 a year less than it used to be.

Can you imagine that person being terribly happy with the way their finances have fared under the Albanese government? My guess is, there’ll be growing disaffection with Labor as next year progresses.

To help him win last year’s federal election, Albanese made Labor a “small target” by promising very little change, including no change to the stage three income tax cuts, legislated long before the pandemic, to start in July next year.

His game plan had been to spend his first term being steady and sensible, keeping his promises and being an “economically responsible” government. This would get him re-elected with an increased majority and able to implement needed but controversial reforms.

But, through no great fault of his own, he’s had to grapple with the worst surge in the cost of living in decades. If there’s a low-pain way to get inflation back under control, I’ve yet to hear about it.

The trouble set in well before the change of government, and the Reserve Bank began its long series of interest rate rises during the election campaign.

My guess is that Albanese’s hopes of storming back to power at an election due by May 2025 are dashed. But it’s hard to see Peter Dutton winning the election unless he can win back the Liberal heartland seats that went to the teals, which seems doubtful.

So, it’s not hard to see Albanese losing seats and reduced to minority government, dependent on the support of the Greens and teals.

There is, however, one thing he could do to cheer up many voters: rejig the coming tax cuts so the lion’s share of the $25 billion they’ll cost the budget goes not to the high-income taxpayers who’ve had the least trouble coping with living costs, but to those on lower incomes who’ve the most.

Read more >>

Why your income tax refund is so much less than last year's

The political hardheads in Canberra are convinced much of the resounding No vote in the Voice referendum is a message from voters that they want the Albanese government fully focused on the cost of living crisis – which is really hurting – not wasting time on lesser issues.

I suspect they’re right. But if so, it’s the consequence of years of training by politicians on both sides that we should vote out of naked self-interest, not for what would be best for the country.

So, as the government switches to moving-right-along mode, expect to hear a lot from Anthony Albanese and Treasurer Jim Chalmers on how much they feel our pain and the (not so) many things they’ve done to ease the pain.

If that pain gets a lot worse – or just if the cries of anguish get a lot louder – expect to see the government doing more. If the Reserve Bank has miscalculated and, rather than just slowing to a crawl, the economy starts going backwards, expect to see the two of them spending, big time.

There’s no denying that, for most of us – though by no means everyone (see footnote) – it’s become a weekly struggle to make ends meet. Paradoxically, this is partly because of the post-lockdowns surge in many prices and partly because of the Reserve Bank’s efforts to stop prices rising so fast by ramping up interest rates.

Mortgage interest rates at present are not high by past standards. Two factors explain the pain from mortgages. First, thanks to higher house prices, the size of loans is much bigger than it used to be.

Second, after lowering interest rates to rock bottom during the lockdowns, the Reserve unexpectedly raised them by a huge 4 percentage points within just 13 months.

Households with big home loans, roughly a quarter of all households, have had their belts tightened unmercifully. Less usually, the third of households that rent have seen their rents rise by 10 per cent in the past 18 months; more than that in Sydney and some other capital cities (but not Melbourne, according to Australian Bureau of Statistics figures).

To this, add the big rises in the cost of petrol, electricity and gas, home insurance, overseas travel and various other things. Most people’s wages have not kept up with the rise in prices.

So yes, the cost of living crisis is no media exaggeration. And Albanese and Chalmers are full of empathy on all the elements I’ve listed. But there’s one other contribution to the crisis that many people will have stumbled across without understanding what was hitting them.

It’s below the radar because Albanese and Chalmers do not want to talk about it. Nor does the ever-critical opposition. As a consequence, most of the media have not woken up to it – with the notable exception of this august organ.

But according to Dr Ann Kayis-Kumar, a tax lawyer at the University of NSW, one of the most Googled questions in Australia in recent times is “Why do I suddenly owe tax this year?” A related question would be, why is my tax refund so much smaller than last year’s?

I’ll tell you (and not for the first time). Preparing for former treasurer Josh Frydenberg’s last budget, just before the election in May 2022, the Morrison government decided to increase the “low and middle income tax offset” (dubbed the LAMIngTOn) from $1080 to $1500, but not to continue it in the 2022-23 financial year.

Frydenberg made much of the increase, but governments that decide not to do things aren’t required to announce the fact. So Frydenberg didn’t. And Chalmers, watching on, said nothing.

The tax offset was a badly designed measure and all the insiders were pleased to see the end of it. I was too but, as a journalist, felt it was my job to tell the people affected what the politicians didn’t want them to know: that, in effect, their income tax in 2022-23 would be increased by up to $1500 for the year.

The 10 million taxpayers affected have been getting the unexpected news in just the past three months or so, after submitting their tax returns and discovering their refund was much less than last year’s, or had even turned into a small debt to the Tax Office.

The full tax offset went to those earning between $48,000 and $90,000 a year, which was most of the 10 million. Our friendly tax lawyer notes that the median taxable income in 2020-21 was $62,600, leaving $90,000 well above the middle.

Disclosure: Having paid off my house decades ago, and being highly paid (as are politicians), I haven’t felt any cost of living pain. Which makes me think that, when the people who are feeling much pain see Albo and Jimbo giving people like me a long-planned $9000-a-year tax cut next July, while they get chicken-feed, they might be just a teensy weensy bit angry.

Read more >>

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Read more >>

Albanese's big chance to improve inflation, productivity and wages

Are Anthony Albanese and his ministers a bunch of nice guys lacking the grit to do much about their good intentions? Maybe. But this week’s announcement of a review of competition policy raises hope that the nice guys intend to make real improvements.

The review, which will provide continuous advice to the government over the next two years, has been set up because “greater competition [between Australia’s businesses] is critical for lifting dynamism, productivity and wages growth [and] putting downward pressure on prices”, Treasurer Jim Chalmers says.

As I wrote on Monday, the great weakness in our efforts to reduce high inflation has been our assumption that its causes are purely macroeconomic – aggregate demand versus aggregate supply – with no role for microeconomics: whether businesses in particular industries have gained the power to push their prices higher than needed to cover their increased costs.

But it seems Chalmers understands that. “Australia’s productivity growth has slowed over the past decade, and reduced competition has contributed to this – with evidence of increased market concentration [fewer businesses coming to dominate an industry], a rise in markups [profit margins] and a reduction in dynamism [ability to change and improve] across many parts of the economy,” he says.

The former boss of the Australian Competition and Consumer Commission, Rod Sims, had some pertinent comments to make about all this at a private business function last week.

He observes that “companies worked out long ago that the essence of corporate strategy is to gain market power and erect entry barriers. Profits from ‘outrunning’ many competitors from a common starting point are generally small; profits from gaining market power are usually large.

“Businesspeople know that when the number of competitors gets too large, price competition is often the result, and that this ‘destroys shareholder value’ or, alternatively put, helps consumers.”

Sims says the goals of growing and sharing the economic pie are being damaged in Western economies, and in Australia, by inadequate competition leading to market power. But, aside from the specialists, the economics profession more broadly has been slow to realise this and factor it into policy responses.

Australia has an extremely concentrated economy, Sims says. We have one dominant rail freight company operating on the east coast, one dominant airline with two-thirds of the market, two beer companies, two ice-cream sellers and two ticketing companies, all with a 90 per cent share of their markets.

We have two supermarkets with a combined market share of about 70 per cent. We have three dominant energy retailers and three dominant telecommunications companies. We have four major banks, with a 75 per cent share of the home mortgage market.

This is much greater concentration than in other developed countries. And, as you’d expect, the profit margins of these companies generally exceed those of comparable companies overseas.

The centuries that businesses have spent pursuing economies of scale explain why we don’t have – and shouldn’t want - the huge number of small firms assumed by the economic theory burnt on the brains of most economists.

But, Sims argues, our relatively small population doesn’t justify the much greater concentration of our industries. For one thing, studies of Australian industry sectors show that the returns to scale stop increasing well before market shares are anything like as high as they are in Australia.

For another, Australia’s modest size doesn’t explain why our industries are getting ever more concentrated, so that our key players are less likely to be challenged by competitors.

And it’s not just our high concentration, it’s also that we see large asset-managing institutions with big shareholdings in most of the firms dominating an industry. Thus, asset managers have an interest in keeping the whole industry’s profits high by limiting price competition between the companies.

One study, of 70,000 firms in 134 countries, found that the average prices charged by our listed companies were 40 per cent above the companies’ marginal cost of production in 1980, and about the same in the late 1990s. But by the early 2000s, average prices were 40 per cent above marginal cost. By 2010, they’d risen to 50 per cent above, and by 2016 it was nearly 60 per cent.

Analysis by federal Treasury has found that our companies’ markups increased over the 13 years to 2017.

The evidence in Australia and overseas is that in concentrated industries we see less dynamism, lower investment and lower productivity, Sims says. Our productivity performance has been very poor at a time when our focus on pro-competition public policy appears to have been lost.

It’s not hard to believe that the latter explains the former. “We run harder when competing versus when we run alone,” Sims says.

Our Treasury’s research also shows that firms in concentrated markets are further from the productivity frontier as there’s less incentive to keep up.

And market concentration also has implications for wage levels. Where labour mobility – the ease with which people move between employers – is reduced, wage levels are lower.

But high industry concentration means fewer firms that workers can move to, bringing relevant skills, and fewer new firms entering the industry. Less competition for workers means lower wages.

“Non-compete clauses” make the problem worse. Recent Australian studies have shown that more than one in five employees are prevented from working for competitors under such contract terms, often even in fairly low-skilled jobs.

Another finding is that the benefits of improved productivity are less shared with workers in concentrated industries. The share of productivity gains going to workers has declined by 25 per cent in the last 15 years, Sims says.

So next time some business person, politician, Reserve Bank governor or other economists tells you higher productivity automatically increases everyone’s wage, don’t fall for it. Used to be true; isn’t any more.

All this says that if the Albanese government is fair dinkum about getting inflation down and productivity and wages up, it will at least ban non-compete clauses and tighten up our merger laws.

Read more >>

We won't fix inflation while economists stay in denial about causes

Led on by crusading Reserve Bank governors, the nation’s economists are determined to protect us from the scourge of inflation, no matter the cost in jobs lost.

But there’s a black hole in their thinking about the causes of inflation, only some of which must be stamped on. Others can be ignored. Meanwhile, here’s another sermon demanding the government act to raise productivity.

In your naivety, you may think that inflation is caused by businesses putting up their prices. But economists know that’s not the problem. Businesses raise their prices only in response to “market forces”. When demand for their products exceeds the supply, businesses seize the chance to raise their prices.

In your ignorance, you may think they do this out of greed, a desire to increase “shareholder value” at the expense of their customers. But that’s the wrong way to look at it.

In raising their prices, businesses aren’t being opportunistic, they’re only doing what comes naturally, playing their allotted role in allowing the “price mechanism” to bring demand and supply back into balance.

As balance is restored, the price will fall back, pretty much to where it was before. What? You hadn’t noticed? Funny that, neither had I.

No, what causes prices to keep rising at a rapid rate is when the greedy workers and their unions force businesses to increase their wages in line with the rise in the cost of living. Can’t the fools see that this merely perpetuates the rapid rise in prices?

So, what we need to get inflation down quickly is for workers to take it on the chin. They can have a bit of a pay rise – say, 2.5 per cent – but nothing more, especially when there’s been no increase in the productivity of their labour.

This will cut the workers’ real incomes and lower their standard of living, of course, but that can’t be helped. It’s the only way we can make them stop spending as much, so businesses won’t be able to get away with continuing to raise their prices by more than 2.5 per cent.

But cutting real wages probably won’t be enough to stop businesses raising their prices so high, so we’ll need to raise interest rates and really put the squeeze on workers with big mortgages. Sorry, nothing else we could do.

Yet another worry is our return to full employment. If the demand for labour exceeds its supply, that would allow the suppliers of labour – aka workers – to raise their prices – aka wages – and that would never do.

Indeed, our history-based calculations say the unemployment rate has already fallen below the level that causes wage and price inflation to take off. It hasn’t yet, but it will.

But not to worry. As incoming Reserve Bank governor Michele Bullock explained in a speech extolling full employment, the Reserve estimates it should only be necessary to raise the rate of unemployment by 1 percentage point to 4.5 per cent to get inflation back down to where we want it.

What! Cried the punters in stunned amazement. To get inflation down you will knowingly put about 140,000 workers out of work? How could you be so utterly inhuman?

What stunned and amazed the nation’s economists is that anyone should be surprised or offended by this. Don’t they know that’s the way we always do it? And 140,000 job losses would be getting off lightly.

Just so. When, as now, the Reserve Bank and the government accidentally overstimulate the economy, allowing businesses to increase their prices by more than they need to, what we always do to stop businesses raising their prices is bash up their customers until the fall-off in households’ spending – caused partly by people losing their jobs – makes it impossible for businesses to keep increasing their prices.

Problem solved. Standard practice is to put a stop to businesses’ opportunism – their “rent-seeking” as economists say – by bashing up their workers and customers until the businesses desist.

But what never happens is that the level of prices falls back to about where it was before the econocrats stuffed up – as the economists’ price-mechanism theory promises it will.

Why doesn’t the theory work? Because what’s required to make it work is intense competition between many small firms. When one firm decides to raise its prices and fatten its profit margin, the others undercut it and it either pulls its head in or goes out backwards.

In the real world, industries are increasingly dominated by just a few huge firms – firms that have become so mainly by taking over their smaller competitors. This is true in all the rich economies, but none more so than ours.

Economists know that “oligopolies” form because it’s easier for a few big firms to gain a degree of control over the prices they charge (whereas the price-mechanism theory assumes they’re too small to have any control).

The few big players compete on marketing and advertising, and using minor product differentiation, but never on price. When prices rise, they rise together – and rarely come back down.

Economists know all this – it’s knowledge gained and taught by economists – but it’s classed as “microeconomics”, whereas the econocrats seeking to manage the economy and keep inflation low specialise in “macroeconomics”. And they never join the dots – though that’s changing in other countries.

This year the European Central Bank, the International Monetary Fund and the Organisation for Economic Co-operation and Development have delved into the national accounts and determined that rising profit margins explain a high proportion of the recent inflation surge.

But when the Australia Institute replicated this analysis for Australia, both Treasury and the Reserve Bank used dodgy graphs and dubious arguments to dismiss its work as “flawed”.

Entrenched inflation only emerged as a problem in the 1970s. After much debate, the world’s economists decided the problem was caused by powerful unions, whose expectations of continuing high inflation caused a “wage-price spiral”, which could only be broken by using high interest rates to put the economy into recession.

This is the thinking we’ve had full strength from the Reserve for the past year or more. Since the 1970s, however, multiple developments have weakened the unions’ bargaining power, while decades of takeovers have increased our big businesses’ pricing power – without the econocrats noticing.

And despite their unceasing sermons about the need for governments to increase national productivity, it’s never occurred to them that the primary driver of productivity improvement is intense competition between businesses.

The calls by successive heads of the Australian Competition and Consumer Commission for stronger powers to block mergers that would “substantially lessen competition” have gained no support from the Reserve, Treasury or economists generally.

But we won’t fix inflation until we have stronger laws defending competition.

Read more >>

RBA's double whammy: hit wages and raise interest rates

If the sharp increase in interest rates we’ve seen leads to a recession, it will be the recession we didn’t have to have. The judgment of hindsight will be that the Reserve Bank’s mistake was to worry about wage growth being too high, when it should have worried about it being too low.

The underrated economic news this week was the Australian Bureau of Statistics’ announcement that its wage price index grew by 0.8 per cent over the three months to the end of June, and by 3.6 per cent over the year to June.

This was the third quarter in a row that wages had risen by 0.8 per cent, but annual growth was down a fraction from 3.7 per cent over the year to March. It was a slowdown the Reserve hadn’t expected.

So, the obvious question arises: is it good news or bad? Short answer: depends on your perspective. Long answer: keep reading.

The Reserve would have regarded the modest fall as good news because its focus is on getting the rate of inflation down to its 2 to 3 per cent target range as soon as reasonably possible. The slight lowering in wage growth will help in two ways.

First, it means a slightly smaller increase in businesses’ wage costs, which should mean they increase their prices by a little less.

Second, the slight fall in wage growth slightly increases the squeeze on households’ incomes, making it a little harder for them to keep spending as much on goods and services. The less the demand for their products, the less the scope for businesses to raise their prices.

It’s hardly a big change, obviously, but it’s in the right direction. It’s a sign the Reserve’s anti-inflation strategy is working and that the return to low inflation may happen a little earlier.

But what if you’re just a worker – is it good news or bad, from your perspective? Well, Treasurer Jim Chalmers would like to remind you that wage growth of 3.7 or 3.6 per cent is the highest we’ve had since mid-2012.

Not bad, eh? Trust Labor to get your wages up.

I trust you’re sufficiently economically literate to see through that one. Back then, the annual rate of inflation was about 2 per cent, whereas in June quarter this year it was 6 per cent – not long down from a peak of 7.8 per cent.

So wage growth of 3.6 per cent is hardly anything to boast about. Wages might be up, but prices are up by a lot more. Take account of inflation, and “real” wages actually fell by 2.4 per cent over the year to June.

Over the 11 years to June, consumer prices rose by 33 per cent, whereas the wage price index rose by 29 per cent. If you’re a worker, that’s hardly something to celebrate.

Why do ordinary people put up with the capitalist system, in which big business people are revered like Greek gods, permitted to lecture us on our many failings, and allowed to pay themselves maybe 40 times what an ordinary worker gets?

Because the punters get their cut. Because enough of the benefits trickle down to ordinary workers to give them a steadily improving standard of living. Because wages almost always rise a bit faster than prices do.

This is the “social contract” the rich and powerful have made with the rest of us for letting them call the shots. But for the past decade or more we’ve got nothing from the deal. Indeed, our standard of living has slipped back.

Don’t worry, say Chalmers and his boss Anthony Albanese, it won’t be more than a year or three before inflation’s down lower than wage growth and real wages are back to growing a bit each year.

Yeah, maybe. It’s certainly what should happen, it happened in the past, so maybe it will happen again. But one thing we can be sure of: we’re unlikely ever to catch up for the losing decade.

Throughout the Reserve’s response to the post-pandemic period, it’s had next to nothing to say about the abandon with which businesses have been whacking up their prices, while always on about the need for wage growth to be restrained.

It’s tempting to think that, in the mind of the Reserve, the only function wages serve is to help it achieve its inflation target. When inflation’s below the target, the Reserve wants bigger pay rises to get inflation up. When inflation’s above the target, it wants lower pay rises to get inflation down.

The truth is, the Reserve’s been mesmerised by the threat that roaring wages would pose to lower inflation. Its limited understanding of the forces bearing on wages is revealed by its persistent over-forecasting of how fast they will grow.

Once the unemployment rate began falling towards 3.5 per cent and the jobs market became so tight – with job vacancies far exceeding the number of unemployed workers – it has lived in fear of surging wages as employers bid up wages in their frantic efforts to hang on to or recruit skilled workers.

It just hasn’t happened. As we’ve seen, wages haven’t risen enough merely to keep up with prices, much less soar above them.

The Reserve has worried unceasingly that the price surge would adversely affect people’s expectations about inflation, leading to a wage-price spiral that would keep inflation high forever. This is why it’s kept raising interest rates and been rushing to see inflation fall back.

Again, it just hasn’t happened.

Normally, when inflation’s been surging and the Reserve has been raising interest rates to slow down our spending, real wages have been growing strongly. But not this time. This time, falling real wages have greatly contributed to the squeeze on households and their spending.

That’s why, if this week’s falling employment and rising unemployment continue to the point of recession, people will realise the Reserve’s mistake was to worry about wage growth being too high, when it should have worried about it being too low.

Read more >>