Making sense of the budget surplus saga

I hate to burden you with a topic as earnest as the budget deficit so close to the holidays - I had hoped to write about the idea of giving someone a goat for Christmas - but the saga of whether the Gillard government will manage to get its budget into surplus this financial year has reached farcical proportions.

A few weeks ago we learnt from the national accounts that the economy's rate of growth slowed to 0.5 per cent in the three months to September. When some parts of the media concluded the most significant implication of this news was that it increased the likelihood of the budget balance not returning to surplus (which it does) I realised the public debate was running off the rails.

Contrary to the impression we are being given, the budget balance is a means to an end, not an end in itself. We don't run the economy to balance the federal government's budget. And when we get our quarterly report on how the economy's travelling, the primary question is not what it tells us about the government's performance or it political prospects.

The budget was made to serve the economy, not the other way round. And the economy was made to serve us. So the primary question to be asked when we receive the quarterly report card is what it implies for us. Is our material standard of living improving more slowly than we'd prefer? Is inflation getting worse? Is the economy growing fast enough to stop unemployment rising?

These things matter because they matter to us and our lives. It's only because they matter to us that they also matter to the fortunes of the governments we re-elect or toss out. So the economic implications of the budget balance come first, the political implications are very much secondary.

Trouble is, for both the public and the media, the political implications of the budget balance are deceptively simple, whereas the economic implications are complicated and, to many, incomprehensible.

Politically, the only thing people think they need to know is that anything called a deficit must be bad and anything called a surplus must be good. Most political reporting about the budget balance is based on this assumption.

The opposition has been reinforcing this simplistic reasoning unceasingly from the moment in 2009 it became clear the global financial crisis had pushed the budget balance into deficit. Its success explains why, in the election campaign of 2010, a foolhardy Julia Gillard took a mere Treasury projection that the budget would be back in surplus by 2012-13 and elevated it to the status of a solemn promise.

Economically, however, it ain't that simple. From an economic perspective, budget deficits are bad in some circumstances, but good in others. Similarly, budget surpluses are good in some circumstances but bad in others.

How could this be so? It's because national government budgets operate at two quite different levels. At one level the government's budget is the same as that for a business or a household: it's a forecast of how much money will be coming in and going out during a year. You use budgets to ensure things go to plan and you don't get in deeper than you can handle.

At another level, however, the budgets of national governments are quite different from other budgets. Because they're so big relative to the size of the economy - equivalent to about a quarter - what's happening to the economy has a big effect on the budget. But the budget is so big it can also be used to affect what happens to the economy.

This is something few non-economists seem to understand. People who focus solely on the political implications of the budget, assume that if the budget moves from surplus to deficit this could only be because the government has chosen to spend more than it is raising in taxes. If the budget moves from deficit to surplus, this could only be because the government has chosen to spend less than it's raising in taxes.

Not so. The other reason budgets go from surplus to deficit is that when the economy turns down, this causes tax collections to slow or even fall and government spending (particularly on unemployment benefits) to grow rapidly. Similarly, the other reason budgets go from deficit to surplus is that the economy speeds up, causing tax collections to grow rapidly and spending on unemployment benefits to fall as more people find jobs.

This automatic deterioration in the budget balance is what happened after the financial crisis hit business and consumer confident so hard. In this case, the descent into deficit was good, not bad. Why? Because it represented the budget helping to break the economy's fall during the downturn.

What complicates matters was Kevin Rudd's decision to use a temporary burst of government spending to stimulate the economy out of its downturn. At this point we had the economy making the budget balance worse automatically, but also the government choosing to add to the worsening as a way of hastening the economy's eventual recovery.

But just as the budget balance deteriorates automatically when the economy turns down, so it improves automatically when the economy recovers and resumes its growth. Treasury's projection the budget would be back in surplus by 2012-13 was based mainly on its assumption of a strong recovery in tax collections.

This hasn't been happening, thus making the return to surplus unlikely. From an economic perspective, it's the weak recovery that's worth worrying about, not the delayed return to surplus. From an uncomprehending political perspective, however, that won't save Gillard from a caning.

Read more >>

Executives put their salaries ahead of shareholders

For almost as long as big business has been crusading for a lower rate of company tax, I've been puzzling over its motives. Why are these people fighting for something of little or no benefit to their domestic shareholders and likely to be quite unpopular?

The willingness with which our economic establishment has gone along with the calls for lower company taxes is one of the great mysteries of the year. . Now the Organisation for Economic Co-operation and Development has signed up as an urger in its latest report on Australia.

But as David Richardson demonstrated on Saturday in his technical brief for the Australia Institute, claims that a lower rate of company tax would lead to more investment, faster economic growth and higher employment are surprisingly weak when you bother to examine them.

The puzzle doesn't end there, however. If lower company tax was of benefit to shareholders, it wouldn't be surprising to see big business arguing for it, even if it was of little or no benefit to the wider economy. But even this motivation doesn't hold.

The push for lower company tax is enthusiastically pursued in the United States, and this wouldn't be the first reform push we'd imported holus-bolus from there. Just one small problem: we have a full dividend imputation system that the Yanks don't have.

It wouldn't be all that surprising if many economists - and many punters - weren't quite on top of how dividend imputation affects the push for a lower company tax rate. It would be amazing, however, if our chief executives didn't understand it. You'd also expect a lot of investment professionals - fund managers, their myriad consultants, stockbrokers - to know the score.

The point is simply stated: when the rate of company tax is 30 per cent, the recipients of fully franked dividends are entitled to a refundable tax credit worth 30 per cent of the grossed-up value of the dividend.

So if your marginal tax rate is 46.5 per cent, the extra income tax you have to pay on your grossed-up dividend falls to a net 16.5 per cent. In this way the double taxation of dividends is eliminated.

Now let's say the big business lobby succeeds in persuading the government to cut the company tax rate to 25 per cent. With an unchanged dividend, the refundable tax credit falls to 25 per cent and the remaining tax to be paid rises to 21.5 per cent.

Only if companies were to respond to the lower company tax rate by increasing their dividend payouts sufficiently, would domestic shareholders not see themselves as having been made worse off.

The introduction of dividend imputation led to a reduction in listed companies' efforts to minimise their company tax because Australian investors much prefer to hold the shares of companies paying enough tax to allow them to fully frank their dividends. Companies unable to deliver fully franked dividends can expect their share price to be marked down accordingly.

This is particularly true of Australian super funds, which are able to use imputation credits to largely extinguish the 15 per cent tax they pay on their annual investment earnings. (This tax quirk probably explains why our super funds are overinvested in shares and underinvested in fixed-interest areas.)

When you remember the way our chief executives bang on endlessly about shareholder value being their sole and sacred objective, you can only wonder why they pursue a cut in the company tax rate so fervently.

They're always distributing league tables showing our 30 per cent company tax rate as the equal seventh-highest among the 34 countries in the OECD. They never point to tables showing the combined effect of the company tax rate and the top personal tax rate. If they looked at it from this domestic shareholders' perspective, we'd fall to being just the 15th highest, with the US and Britain well above us.

For a long time I wondered whether the Business Council - many of whose members are largely foreign-owned - was championing the interests of foreign shareholders rather than locals.

It's true many foreign shareholders in Australian companies would benefit from a lower company tax rate because they're not eligible for imputation credits. One of the main reasons for the continued existence of company tax is to ensure the foreign owners of Australian businesses pay their fair share of Australian tax.

But not even all foreign shareholders would benefit from lower company tax. Americans (who account for more than a quarter of the stock of foreign investment in Australia) would gain nothing because the company tax rate they pay when they bring dividends home is already higher than our 30 per cent (for which they get a deduction). They wouldn't gain, but our Treasury would lose.

So what is big business on about? In his paper for the Australia Institute, Richardson argues it's a case of company executives pursuing their own interests, not those of the shareholders they profess to serve. (Economists call this a principal-and-agent problem.)

A lower rate of company tax would make companies' after-tax profits bigger, thus making their chief executives look more successful and probably leading to an increase in their remuneration.

It would also allow companies to retain and reinvest more after-tax earnings. This would make their companies bigger - which would probably also justify bosses being paid higher remuneration.

We already know chief executives play such self-seeking games because of all the mergers and takeovers, which rarely leave shareholders better off, but invariably leave the instigating chief executive more highly paid.

Read more >>

The case against a lower company tax rate

One of big business's greatest disappointments this year was its failure to persuade the Gillard government to cut the 30 per cent rate of company tax. On business's economic reform wish-list, cutting company tax is second only to getting more anti-union provisions back into industrial relations law.

So you can be sure business will be campaigning for lower company tax in the months leading up to next year's federal election.

I'm sure many business people regard the benefits of lower company taxation as so obvious as to be self-evident but, in economics, you have to spell out just why you believe a lower tax rate would make the economy a better place.

Presumably, the argument is that lower company tax would encourage greater investment in business activity, thus making the economy grow faster and create jobs.

It's surprising there's been so little debate of this proposition among supposedly argumentative economists - until now. On Saturday, the Australia Institute will publish on its website a technical brief by David Richardson, "The Case Against Cutting the Corporate Tax Rate".

According to Richardson, company tax has the great virtue of being a tax on profit. If you don't make a profit, you don't pay the tax. So company tax doesn't add to the cost of doing business, meaning the imposition of the tax makes no difference to the profitability of business activities. And, since the tax is applied at the same rate to profits from all business activities, it should have no effect on decisions about which activities to pursue, or how much activity to undertake.

"By contrast, many other taxes are payable whether or not the company makes a profit," Richardson says. "For example, the iron ore royalty rate in Western Australia will soon be 7.5 per cent of the value of the iron ore mined. If the mining company receives $100 a tonne, pays $7.50 in royalties and has expenses of $95 a tonne, it will run at a loss ... There is no way a profit-related tax can do that."

In exposing this logical flaw in the argument that the rate of company tax affects the amount of business activity undertaken, Richardson quotes the Nobel laureate Joseph Stiglitz from a book he published this year, The Price of Inequality: "If it were profitable to hire a worker or buy a new machine before the tax, it would still be profitable to do so after the tax ... what is so striking about claims to the contrary is that they fly in the face of elementary economics: no investment, no job that was profitable before the tax increase, will be unprofitable afterward."

Richardson reminds us that, according to elementary economics, investment will continue until the return on the marginal investment is just equal to the cost of capital. This is true whether you evaluate the investment on a pre-tax or post-tax basis. Why? Because, although company tax will reduce the return on the investment, it will also reduce the (after-tax) cost of capital. If returns are taxed, interest costs become tax deductible.

Richardson notes that the economists Gravelle and Hungerford, of the US Congressional Research Service, who reviewed the empirical evidence that might or might not support claims that lower company tax increases economic growth, debunk the notion.

It's widely argued that because Australia is a "capital-importing country" and needs a continuous inflow of foreign equity investment, we need to keep our company tax rate competitive if we're to attract all the funds we need. Since other countries have been lowering their rates, we must lower ours.

But Richardson says Gravelle and Hungerford showed "there was no convincing empirical evidence that suggested international capital flows were influenced by corporate tax rates. The differences among Organisation for Economic Co-operation and Development [member countries'] rates tend to be so small as to hardly matter compared with other factors".

He says a good deal of foreign investment in Australia comes from Asian countries with much lower company tax rates than ours. In 2011, China was the third-highest foreign investor in Australia by value during the year, while India was fifth, Singapore was sixth, Thailand 12th and Malaysia 14th.

"The simple point is that Australia attracts investments originating in the very economies that are supposed to have more competitive taxation systems," he says.

Note that the US accounts for 27 per cent of the accumulated stock of foreign investment in Australia, Britain for 23 per cent and Japan for 6 per cent.

An argument against cutting our company tax rate is that, because of the way double-taxation agreements between countries work, where foreign investors in Australia come from countries whose company tax rate is higher than ours - such as the US - they gain no advantage from our lower rate. What they save in payments to our taxman just increases their payments to their own taxman.

When, at a tax summit last year, the ACTU expressed opposition to a cut in company tax, business and its economist supporters retorted that, when you work it through, the burden of company tax ends up being borne mainly by wage earners.

That is, businesses pass the burden of company tax on to their customers in the form of higher prices, and most customers are wage earners. Didn't the unionists know this? Why were they so ill-informed?

It's true that, being inanimate objects, companies don't end up paying tax: only people pay tax. So the burden of company tax must be shifted to customers, employees or shareholders, or some combination. But determining just who, in practice, ends up shouldering the burden of a tax is notoriously hard.

It's true, too, there's been a rash of studies purporting to show it's the workers who end up carrying the can. But the Congressional Research Service report criticised those studies and showed their results were unrealistic.

One study, for instance, estimated a 10 percentage-point increase in the corporate tax rate would reduce annual gross wages by 7 per cent. But when Richardson applied that rule to our economy, he found it was saying such a move would increase company tax collections by $22.5 billion and reduce wages by $49.6 billion.

Pretty hard to believe. Incredible, in fact. The economic case for a lower company tax rate is surprisingly weak.

Read more >>

Poverty rises as you move from the centre

In Bill Bryson's fascinating book, Shakespeare, he says we know remarkably little about the man, and most of what we think we know has been dreamt up by overenthusiastic scholars. But of at least one point he was sure: in Shakespeare's London, rich and poor lived side by side. A case, I guess, of the rich man in his castle, the poor man at his gate.

They don't make cities like that anymore. Or rather, modern cities seem to be a lot more socially segregated, with the rich tending to live together on one side of the tracks and the poor living on the other.

Research undertaken some years ago by economists at the Australian National University found Australian cities had become more divided, and there is much American research to similar effect. But a research report to be issued on Wednesday has found something a bit different. It is Promoting Inclusion and Combating Deprivation, by Professor Peter Saunders and Dr Melissa Wong, of the Social Policy Research Centre at the University of NSW.

They conducted a survey of 6000 people drawn at random from around Australia in May 2010. They got more than 2600 responses, which they divided into six categories according to where people lived: inner metropolitan area, outer metropolitan, large towns (more than 25,000 people), larger country towns (more than 10,000 people), small country towns (fewer than 10,000 people) and rural areas.
Advertisement

Not surprisingly, they found there were poor, socially disadvantaged people living in all areas. But they also found a strong correlation between where people live and how likely they are to be socially disadvantaged. As the degree of population concentration declines, the rate of social disadvantage tends to increase. To be blunt, the further out you go from the centre of big cities, the higher the proportion of poor people you find.

After allowing for family size, the average disposable income of households was $970 a week. But inner metropolitan households averaged 12 per cent above this, whereas rural households averaged 14 per cent below. (Of course, if some locations have a higher proportion of retired people, the average income will be lower.)

In inner metropolitan areas, the proportion of households living in poverty (that is, with incomes below half the median income) was 12 per cent. It rose to 12.4 per cent in outer metropolitan, 12.6 per cent in large towns, 14.8 per cent in larger country towns and 16.8 per cent in small country towns, dropping a little to 15.5 per cent (still the second highest rate) in rural areas.

Those poverty rates were calculated by the researchers. When the survey respondents were asked whether they considered themselves to be living in poverty, their answers followed pretty much the same pattern.

What's notable, however, is that their subjective assessments were about 2 percentage points lower than the calculated rates. So, unlike many of the rest of us, the genuinely poor don't seem to be feeling particularly sorry for themselves.

But poverty – how much money you have to spend – is not the only dimension of social disadvantage. And there's been controversy over the unavoidable arbitrariness of where poverty lines are drawn. So Saunders and his colleagues have put much work into developing a different approach, one based on people's access to 24 items that a majority of Australians responding to an earlier survey regard as the "essentials of life".

The items include a substantial meal at least once a day, warm clothes and bedding, a washing machine, a decent and secure home, roof and gutters that don't leak, a separate bed for each child, presents for family or friends at least once a year, being able to buy medicines prescribed by a doctor, and up to $500 in savings for an emergency.

When you assess the respondents to the latest survey according to their access to these essentials you find the same story: deprivation tends to rise as you progress from inner metropolitan to rural. The highest levels of deprivation are in social functioning (such as regular social contact with other people) and risk protection (such as car insurance).

All very interesting, but also worrying. Higher rates of social disengagement in smaller communities cast doubt on the happy notion that, in the country, everyone knows each other and everyone looks after each other. But it's not surprising that, the further out you are, the less your access to public services such as dentists and childcare. Nor that unemployment rates are usually much higher.

It's possible the socially disadvantaged tend to gravitate to the country – say, because rents are lower. The greater probability, however, is that people living further from the centre are more likely to suffer disadvantage because of the deficiencies of the areas in which they live.

The trouble is, disadvantage breeds disadvantage. Whatever problems you have of your own, they're likely to be compounded if a lot of the people around you have similar problems.

"Once population decline and poverty become entrenched in an area, further problems emerge that act as barriers for those who remain," the researchers say. "The result is that, increasingly, where one lives (or is born) has a major impact on one's life chances."

It follows that, as governments seek to reduce social disadvantage, they should see the disadvantaged not just as individuals needing help, but also as people living in disadvantaged areas – people unlikely to get far unless something is done to improve conditions in their district.

Read more >>

Economics and wellbeing: beyond GDP

Economic Society, Sydney, Tuesday, December 11, 2012

We had been hoping to have a speaker willing to argue that GDP was good enough to guide our policy decisions without need for modification or supplementation, but he’s unable to attend - which is a pity because I would have been interested to hear his arguments. In the absence of someone in the audience willing to argue that position, I think there’s a lot we can agree on. Where we’re likely to differ is in our degree of enthusiasm for the beyond-GDP project and how exactly we should go about developing a supplementary measure or range of measures.

Starting with the ‘agreed facts’, as the lawyers say, I doubt there are many if any economists who need to be lectured by greenies or lefties on the various reasons why GDP is an inappropriate measure of wellbeing or social progress. We all know about defensive expenditures and so forth. Further, we all know GDP was never intended or designed to be such a measure.

And I think all of us here tonight can agree that GDP is a reasonable measure of what it was designed to measure - production and income - and that the continued calculation of GDP is vitally important as an aid to the management of the macro economy. So no one here wants to abolish GDP.

It’s worth noting, however, that the 2009 report of President Sarkozy’s Commission on Economic Performance and Social Progress - the Stiglitz, Sen, Fitoussi report - did offer some significant criticisms of GDP just from a quite conventional, narrow, material wellbeing perspective. It noted that GDP had given Americans in particular an exaggerated impression of how well they were doing in the years leading up to the GFC, with company profits overstated because they were based on asset values inflated by a bubble and with a lot of the growth built on consumers and governments spending money they’d borrowed rather than earnt. It argued that in measuring material wellbeing, the focus should be shifted from production (GDP) to real household income and consumption, since household income can grow at a different rate to GDP. It further argued that income and consumption should be judged in conjunction with households’ net wealth, and that focusing on median income rather than average income is a better, easy way to take at least some account of the distribution of income.

A lot of the report’s criticisms can be met merely by switching from GDP to another aggregate published each quarter in the national accounts (but given almost no attention): real net national disposable income - ‘rinndi’. This measure switches from production to disposable income, takes account of the depreciation of manmade capital, the effect of movements in our terms of trade and the truth that, particularly for an economy with a huge net income deficit like ours, national product is a more appropriate measure than domestic product.

As you may know, I’ve been banging on about the limitations of GDP, and the need for it to be supplemented by a better, broader measure of wellbeing for some time. I was greatly reinforced in this view by the report of such luminaries as Stiglitz and Sen. For more than a year now, Fairfax Media has commissioned Nicholas Gruen to prepare such a broader measure, the Herald-Age Lateral Economics wellbeing index, for publication a few days after the quarterly national accounts.

The HALE index starts by turning GDP into real net national disposable income - rinndi - but then it adds adjustments for as many wider aspects of wellbeing as Nicholas could find decent measures of: the value of the net depletion of natural resources (after allowing for new discoveries), the estimated cost of future climate change, the gain in human capital from all levels of education and training, changes in income inequality, the gain or loss from various measures of the nation’s health and the state of employment-related satisfaction.

If you’re interested in getting your teeth into what a beyond-GDP measure of wellbeing might look like, we’re happy to explain and defend the HALE index. I asked Nicholas to come up from Melbourne tonight for that purpose. We don’t make any claim the index is a complete measure of every dimension of wellbeing, we don’t claim there’s nothing about its methodology that’s open to debate, but we do claim it’s an honest attempt to measure broader wellbeing - welfare, if you like - not some lefty attempt to think of as many negatives as possible to subtract from GDP.

The most obviously debatable part of the methodology is the decision to produce a single, modified-GDP figure for wellbeing. We know Stiglitz and Sen opted for the ‘dashboard’ approach - produce a range of relevant indicators of the various dimensions of wellbeing - rather than a single magic number. And we know the Bureau of Statistics, with all the effort it has put into its MAP project - Measures of Australia’s Progress - is also very much in the dashboard, they-can’t-be-added-up camp. So what are the reasons to prefer a single measure and, once you’ve decided to go down that track, how on earth do you add them together?

These are questions Nicholas, as the designer of the index, is far better qualified to respond to than I am. But I do want to say something from a more psychological, behavioural economics, political economy perspective. Why is it so many people have fallen into the habit of treating GDP as though it was a measure of social progress, even though it isn’t? The first part of my explanation is that economists, by their behaviour rather than their conceptual understanding, have led the uninitiated - politicians, business people, the media - into assuming GDP is the only indicator that matters because they get so excited about it so often, and don’t get so excited about anything else.

They say that what gets measured gets managed, and what doesn’t get measured doesn’t get managed, so if you accept there’s more to our wellbeing that just GDP (or even rinndi) that’s the first reason for wanting to publish something to sit beside GDP. In terms of human psychology, part of the reason for the great attention GDP gets is that new figures are published so frequently and that they’re always changing to an interesting extent.

Finally, we know from the findings of neuroscience that, contrary to our assumption of rationality, humans have surprisingly limited mental processing power and can’t weight up more than one or two dimensions of a problem at the same time, which - among many other implications - means humans are irresistibly attracted to bottom lines - to ‘net net’, as they say in the markets. People want a bottom line, will probably pick one by default, and GDP looks likes it is one. Dashboards may be more methodologically pure, but in a world of human frailty and limited attention, they just don’t cut it.

Read more >>

The hidden truth about interest rates

The prize for journalistic innovation of 2012 must surely go to whoever thought of a way to turn a cut in the official interest rate from good news to (the much more valuable) bad news: abandon the media's eternal assumption that everyone's a borrower and let the grey-power lobby bang on about the evils of lower deposit rates.


It's such an improvement on the standard good-into-bad transformation: bleating about the greedy banks not passing on all the rate cut to people with mortgages.

If we keep down this track we can turn all rate stories into bad news: as Reserve Bank board meetings approach you hold the mike up to all the professional urgers predicting death to the economy if rates aren't cut. Then, when the Reserve obliges, you pass the mike to whingeing oldies.

I suppose it's a good thing for the media to discover at long last that interest rates are a two-way street; that though borrowers gain from lower rates, savers lose. And that there are actually a lot more savers than borrowers.

There's just one problem with the newly fashionable bleeding for retired depositors: it doesn't necessarily follow that a cut in the banks' interest rates for people with home loans leads to similar cuts in rates paid to depositors - a point the grey-power lobby didn't bother making clear to a newly sympathetic media.

There are probably few more underreported topics than what's happening to deposit rates. The banks don't mention them in their press releases announcing cuts for borrowers, and the media rarely press the banks to be more forthcoming.

But even if some of the big four banks shave their deposit rates, I doubt they all will. And those that do are not likely to cut them by as much as the 20 basis points they're lopping off mortgage rates.

Why not? Well, if the media had been reporting the whole affair conscientiously, rather than turning it into a comic-book contest between good guys and bad guys, ripoff merchants and impoverished victims, you'd already know why.

The reason the banks haven't been cutting deposit rates the way they've been cutting mortgage rates goes to the heart of their reason for not passing on official rate cuts in full. Since the onset of the global financial crisis in 2008, the banks have been locked in a battle to attract deposits from ordinary Australian savers.

This battle has forced up the rates being paid to depositors. Whereas before the crisis the rates on at-call savings accounts were about 100 basis points below the official interest rate, today they're on par with it. And whereas term-deposit "specials" were below the equivalent rates paid in the wholesale market (bank bills), today they're about 150 basis points above them.

So, savers ought to be the last people complaining about the way events have transpired since the financial crisis changed the rules of the game. They're laughing all the way to the bank.

Indeed, the higher rates being paid to depositors (relative to where the official rate happens to be), are by far the greatest reason the banks have been imposing "unofficial" rate rises on home (and business) borrowers and now are passing on only about 80 per cent of the official rate cuts. The lesser reason is the higher rates they have to pay on their foreign "wholesale" borrowings.

In other words, it's not the banks that are supposedly ripping off poor home buyers, it's the whingeing retirees. The banks' cost of borrowing has increased, and all they've done is pass the higher cost on by cutting mortgage rates by less than the fall in the official rate.

But that doesn't give people with mortgages a licence to feel hard done by. Why not? Because, as the Reserve's deputy governor, Dr Philip Lowe, reminded us yet again last week, the Reserve has cut the official rate by more than it would have, just to ensure home buyers get the desired degree of rate relief. They haven't been short-changed.

On the face of it, the banks have done nothing wrong. They've merely passed on their higher cost of borrowing, leaving their "net interest margin" (the gap between the average rate they charge and the average rate they pay for funds) at about 230 basis points, virtually unchanged from what it was immediately before the crisis.

But it's not that simple. The question we need to ask is the one the media rarely do: why has the banks' cost of borrowing risen so much since the crisis? And why has a deposit-seeking war broken out among them?

Short answer: because the crisis revealed them to be dangerously dependent on foreign wholesale borrowing for their funds. So, the sharemarket and the credit rating agencies have forced them to lift their reliance on "stickier" retail deposits to about 54 per cent of their total funding.

But this means running a bank is now less risky than it was before the crisis. This, in turn, means their risk-adjusted rate of return on capital no longer needs to be as high as it was.

So, the degree of competition among the banks is sufficient to force them to give depositors a much better deal, and sufficient to have them wanting to preserve their profitability (and their chief executives' remuneration packages) relative to the others, but insufficient to force down their rates of return the way the textbook says should happen.

In all the millions of angry words the media have spilt on the topic this year, the hidden truth is that home borrowers have little to complain about and depositors even less - save for the small truth that our banks remain far more profitable than they need to be.

Read more >>

Economy slowing, not dying

To hear many people talk, the economy is in really terrible shape. Trouble is, we've been waiting ages for this to show up in the official figures, but it hasn't. This week's national accounts for the September quarter are no exception.

You could be forgiven for not realising this, however, because some parts of the media weren't able resist the temptation to represent the figures as much gloomier than they were.

One prominent economist was quoted (misquoted, I trust) as inventing his own bizarre definition of recession so as to conclude the economy was in recession for the first nine months of this year.

Really? Even though figures we got the next day showed employment grew by 1.1 per cent over the year to November, leaving the unemployment rate unchanged at 5.2 per cent? Some recession.

What the national accounts did show - particularly when you put them together with other indicators - is that the economy is in the process of slowing, from about its medium-term trend growth rate of 3.25 per cent a year to something a bit below trend.

That's not particularly good news - it suggests unemployment is likely to rise somewhat - but it hardly counts as an economy in really terrible shape.

The accounts show real gross domestic product growing by 0.5 per cent in the September quarter and by 3.1 per cent over the year to September - which latter is "about trend".

This quarterly growth of 0.5 per cent follows growth of 0.6 per cent in the previous quarter and 1.3 per cent the quarter before that. So that looks like the economy's slowing - although the figures bounce around so much from quarter to quarter it's not wise to take them too literally.

But the accounts contain a warning things may slow further. We always focus on the growth in real gross domestic product, which is the quantity of goods and services produced during the period (and is the biggest influence over employment and unemployment).

But if you adjust GDP to take account of the change in Australia's terms of trade with the rest of the world, to give a better measure of our real income, you find "real gross domestic income" fell by 0.4 per cent in the quarter to show virtually no growth over the year.

Leaving other factors aside, this suggests our spending won't be growing as fast next year, leading to slower growth in the production of goods and services (real GDP) and thus slowly rising unemployment.

Our terms of trade are falling back from their record favourable level because of the fall in coal and iron ore export prices as the first stage of the three-stage resources boom ends. (The second stage is the mining investment boom and the third is the rapid growth in the quantity of our mineral exports.)

For some time the econocrats and other worthies have been reminding us that, when ever-rising export prices are no longer boosting our incomes, we'll be back to relying on improved productivity - output per unit in input - to lift our real incomes each year.

This makes it surprising we've heard so little about the figures showing that GDP per hour worked rose by 0.7 per cent in the quarter and by a remarkable 3.3 per cent over the year. Again, it's dangerous to take short-term productivity figures too literally, but at least they're pointing in the right direction.

They also put a big question mark over all the agonising we've heard about our terrible productivity performance.

This week's figures confirm what we know: some parts of the economy are doing much worse than others. Business investment in plant and construction rose by 2.6 per cent in the quarter and 11.4 per cent over the year - though most of this came from mining, with investment by the rest of business pretty weak.

One area that isn't as weak as advertised is consumer spending, up by 0.3 per cent in the quarter and 3.3 per cent over the year - about its trend rate. The household saving rate seems to have reached a plateau at about 10 per cent of disposable income, meaning spending is growing in line with income.

Investment in home building grew 3.7 per cent in the quarter, suggesting its chronic weakness may be ending, thanks to the big fall in interest rates. Adding in home alterations, total dwelling investment was up 0.7 per cent in the quarter, though still down 6.3 per cent over the year.

The volume (quantity) of exports rose 0.8 per cent in the quarter and 4.7 per cent over the year, whereas the volume of imports rose 0.1 per cent and 3.5 per cent, meaning "net exports" (exports minus imports) are at last making a positive contribution to growth. This suggests we're starting to gain from the third stage of the resources boom, growth in the volume of mineral exports. The greatest area of weakness was spending by governments. Government consumption spending was down 0.4 per cent in the quarter (but still up 3.5 per cent over the year). Government investment spending fell 8.2 per cent in the quarter and 7 per cent over the year even though, within this, investment spending by government-owned businesses was strong.

All told, the public sector made a negative contribution to GDP growth of 0.5 percentage points in the quarter, and a positive contribution of just 0.3 per cent over the year - obviously the consequence of budgetary tightening at both federal and state levels.

This degree of contraction isn't likely to continue. But a strong reason for accepting the economy is slowing somewhat is the news from the labour market.

Don't be fooled by the monthly farce in which unemployment is said to jump one month and fall the next. If you're sensible and use the smoothed "trend estimates" you see unemployment steady at 5.3 per cent since August.

Even so, the economy hasn't been growing fast enough to employ all the extra people wanting work, causing the working-age population's rate of participation in the labour force to fall by 0.4 percentage points to 65.1 per cent.

And we know from the labour market's forward-looking or "leading" indicators - surveys of job vacancies - that employment growth is likely to be weaker in coming months.

That's hardly good, but it ain't the disaster some people are painting.

Read more >>

Wellbeing index gives better picture of mining boom

DON'T believe the doomsayers.This week's national accounts indicate the economy is slowing to something a bit below trend but the critics of the great god gross domestic product are right: it is a quite inadequate and often misleading measure of the nation's progress.

This is why, for more than a year, the Herald has commissioned Dr Nicholas Gruen, principal of Lateral Economics, to calculate a broader index of wellbeing, which we have published within a few days of the release of the Bureau of Statistics' quarterly national accounts, with GDP as their centrepiece.

Our purpose has been to supplement rather than supplant the official figures, which have valid - if narrower - uses and were never intended to be treated as the nation's all-encompassing bottom line.

The Herald-Lateral Economics wellbeing index uses the national accounts to produce a modified version of GDP called "net national disposable income". This adjustment takes account of the annual depreciation (using up) of man-made capital and of the income earned within Australia which isn't owned by Australians.

It also shifts the focus from the value of the nation's production to how much disposable income the nation's households have available to spend on consumption or save, in the process allowing for the change in the prices of our exports relative to the prices of imports.

To this figure the index adds adjustments for the value of the net depletion of natural resources (after allowing for new discoveries), the estimated cost of future climate change, all levels of education and training, changes in income inequality, various measures of the nation's health and employment-related satisfaction.

All this means the index is well placed to help answer a question on many people's minds: what will we have to show for the resources boom?

Unlike GDP, the wellbeing index takes account of the loss of the minerals dug up and sent overseas, not just the export income earned from doing so. It also takes account of the loss of real income we have suffered from the end of the first stage of the boom: the marked decline in the world prices of coal and iron ore during the three months to the end of September.

This was the main factor that converted the growth of 0.5 per cent in GDP during the quarter - a measure of the quantity of goods and services produced in the economy - to a fall of 0.7 per cent in our net national disposable income.

But the accounts confirm that Australian households are continuing to save the high proportion of their disposable incomes. So that is proof we have been saving rather than spending some of our windfall gain from the boom.

But the broader index shows we have also increased our investment in the education and training of our workforce. So much so that, despite the fall in export prices, the index rose by 0.2 per cent during the quarter.

We should be using our good fortune to raise the value of workers' labour and improve their lives in the years ahead - and the wellbeing index shows we are.

Read more >>

Top economist says what we hardly dare to think

Just as it s taking the world a lot longer to recover from the global financial crisis than we initially expected, so it s taking a lot longer than we might have expected for voters and their governments to learn the lessons and make the changes needed to ensure such devastation doesn t recur. But the penny has dropped for some.

Jeffrey Sachs, of Columbia University, is one of the biggest-name economists in the world. Yet in his book, The Price of Civilisation: Economics and Ethics after the Fall, he admits America s greatest problem is moral, not economic. Actually, he says that at the root of America s economic crisis lies a moral crisis. He puts into words thoughts most of us have hardly dared to think.

Sachs says America s weaknesses are warning signs for the rest of the world. The society that led the world in financial liberalisation, round-the-clock media saturation, television-based election campaigns and mass consumerism is now revealing the downside of a society that has let market institutions run wild over politics and public values, he says.

His book tracks the many ills that now weigh on the American psyche and the American financial system: an economy of hype, debt and waste that has achieved economic growth and high incomes at the cost of extreme income inequality, declining trust among members of the society and the public s devastating loss of confidence in the national government as an instrument of public well-being .

Even if the American economy is on the skids, he says, the hyper-commercialism invented in America is on the international rise. So, too, are the attendant ills: inequality, corruption, corporate power, environmental threats and psychological destabilisation.

A society of markets, laws and elections is not enough if the rich and powerful fail to behave with respect, honesty and compassion toward the rest of society and towards the world. America has developed the world s most competitive market society but has squandered its civic virtue along the way.

Without restoring an ethos of social responsibility, there can be no meaningful and sustained economic recovery.

America s crisis developed gradually over several decades, he argues. It s the culmination of an era the baby-boomer era rather than of particular policies or presidents. It is a bipartisan affair: both Democrats and Republicans have played their part.

On many days it seems that the only difference between the Republicans and Democrats is that Big Oil owns the Republicans while Wall Street owns the Democrats.

Too many of America s elites the super rich, the chief executives and many academics have abandoned a commitment to social responsibility. They chase wealth and power, the rest of society be damned, he says.

We need to reconceive the idea of a good society. Most important, we need to be ready to pay the price of civilisation through multiple acts of good citizenship: bearing our fair share of taxes, educating ourselves deeply about society s needs, acting as vigilant stewards for future generations and remembering that compassion is the glue that holds society together.

The American people are generally broadminded, moderate and generous, he says. But these are not the images of Americans we see on television or the adjectives that come to mind when we think of America s rich and powerful elite.

America s political institutions have broken down, so that the broad public no longer holds these elites to account. And the breakdown of politics also implicates the public. American society is too deeply distracted by our media-drenched consumerism to maintain habits of effective citizenship.

Sachs says a healthy economy is a mixed economy, in which government and the marketplace play their roles. Yet the federal government has neglected its role for three decades, turning the levers of power over to the corporate lobbies.

The resulting corporatocracy involves a feedback loop. Corporate wealth translates into political power through campaign financing, corporate lobbying and the revolving door of jobs between government and industry; and political power translates into further wealth through tax cuts, deregulation and sweetheart contracts between government and industry. Wealth begets power, and power begets wealth.

How have American voters allowed their democracy to be hijacked? Most voters are poorly informed and many are easily swayed by the intense corporate propaganda thrown their way in the few months leading to the elections.

We have therefore been stuck in a low-level political trap: cynicism breeds public disengagement from politics; the public disengagement from politics opens the floodgates of corporate abuse; and corporate abuse deepens the cynicism.

Sachs says globalisation and the rise of Asia risks the depletion of vital commodities such as fresh water and fossil fuels, and long-term damage to the earth s ecosystems.

For a long time, economists ignored the problems of finite natural resources and fragile ecosystems, he writes. This is no longer possible. The world economy is pressing hard against various environmental limits, and there is still much more economic growth and therefore environmental destruction and depletion in the development pipeline.

Two main obstacles to getting the global economy on an ecologically sustainable trajectory exist, he says. The first is that our ability to deploy more sustainable technologies, such as solar power, needs large-scale research and development.

The second is the need to overcome the power of corporate lobbies in opposing regulations and incentives that will steer markets towards sustainable solutions. So far, the corporate lobbies of the polluting industries have blocked such measures.

In Australia, of course, the public interest has so far triumphed over corporate resistance. But the survival of both the carbon tax and the mining tax remains under threat.

Read more >>

CitySwitch Awards Night, December 3, 2012

No one ever promised moving to a green economy - an economy making minimal use of fossil fuels - would be easy, and so it has proved. Indeed, in recent years the challenge has look dauntingly tough. It’s too easy to leave it to other people - and other countries - to make the first move. It’s too easy to make excuses and even to deny there is a problem. Sometimes I think I’m glad I didn’t do much science at high school, so I’m not tempted to think I can explain to the scientists where they’re getting it all wrong.

Even so, I get the feeling we’re making more progress in recent days - and that we’ve been making more progress than popularly believed. Here in Australia, the breakthrough may have come with the introduction of the carbon tax on July 1 which - as many of us prophesied - wasn’t nearly as catastrophic as the public had been led to expect. The tax had been designed to be as least disruptive as possible, and so it has proved. With any luck, this anticlimax will see a turning of the tide in our resolve to get on with preparing for a green future. I read that the carbon tax is now more popular than Tony Abbott - though that’s not setting the bar very high. (46/44; -31 net approval)

In recent days we’ve seen a number of new authoritative reports - mainly from scientific authorities, but also from no more unexpected body than the World Bank - reminding us the climate change problem hasn’t been wished away. It’s still there and, if anything, getting more pressing. That’s hardly good news, but I get the feeling these reports have been getting more media attention than they would have done a year ago.

Another bit of encouraging news is that, soon after his comfortable re-election, President Obama reaffirmed his view that man-made emissions of greenhouse gases are contributing to global warming, and stated his intent to continue to take action to reduce greenhouse gas emissions. He said: “I am a firm believer that climate change is real, that it is impacted by human behaviour and carbon emissions,” noting that, “we have an obligation to future generations to do something about it.”

It’s true the US Senate has declined to agree to an emissions trading scheme, but though that may be the best way to progress the move to a green economy, it’s not the only way. And the Obama Administration has made great strides in instituting stringent new fuel efficiency standards for cars and light trucks. A related approach is greenhouse gas regulations issued by the US Environmental Protection Agency, which would limit emissions from certain power plants. And we shouldn’t forget that California and several other states are proceeding with trading schemes.

Similarly, many people don’t realise how much progress China is making in the development of renewable energy sources such as wind and, particularly, solar. When Julia Gillard’s recent white paper on the Asian century included projections for the growth in Chinese demand for our coal, Professor Ross Garnaut expressed the view that these seemed far too high because they underestimated the extent to which China would be relying on green energy sources.

And then, of course, there’s the little publicised fact that the Chinese government is proceeding with an emissions trading scheme on a trial basis in various provinces. Knowing the Chinese way of doing things, I won’t be surprised to see this develop into a nation-wide scheme.

The final bit of good news is the way so many of our own businesses are seizing the challenge and the opportunity to become front-runners in the shift to a green economy. This is occurring in various areas of business, but - as we’ve heard - in none more successfully than in the CitySwitch program. It’s great to see building managers and tenants combining with city councils to use energy more efficiently. They say there are no free lunches in the economy, and it’s true many lunches that look free aren’t really, but there are some, and when you can combine doing the right thing by the planet - and by our grandchildren - with saving on energy costs, this surely qualifies. If doing the right thing and saving on costs also brings competitive advantages - including by making more conscientious employees keener to work for such an enlightened employer - then all I can say is: you deserve it. I’m pleased to be here tonight to honour all the participants in the CitySwitch program as well as those receiving awards.

Read more >>