Experts agree emissions intensity scheme the way to go

If ever there was proof that modern-day politicians are more followers than leaders, Malcolm Turnbull must be it. Last week, under pressure from the Coalition's climate change-denying rump, he dropped the ball on global warming.

He inherited from Tony Abbott a commitment under the Paris agreement to reduce our carbon emissions by 28 per cent below 2005 levels by 2030, plus a plan for a review in 2017 to determine what policies were needed to achieve that target.

Everyone's agreed that the government's existing direct action approach, taking money from the budget to pay farmers and others to cut their carbon emissions, is quite inadequate to achieve the new target.

The authorities responsible for advising the government on energy and climate change – the Climate Change Authority, the Chief Scientist, the Australian Energy Market Commission – have each decided the best approach would be to introduce an "emissions intensity scheme" on the electricity generation industry.

But last week, when Energy Minister Josh Frydenberg mentioned that the review would include examining an intensity scheme, the Coalition's deniers went ape and Turnbull summarily excluded such schemes from the review, claiming they would add too much to electricity costs.

We're not all climate change deniers, however – and far from all Coalition voters – so if we think something decisive should be done, the way forward is to convince Turnbull this is what most of his potential followers want.

In other words, it's our community and our economy and prime ministers don't get to dismiss options without us even being allowed to think about them and decide what we prefer.

Since electricity generation accounts for about a third of our total carbon emissions, it's pretty clear it will be the main focus of our efforts to reduce emissions, especially because of the emergence of renewable energy from wind and solar.

The final report of the energy market commission, released at the Council of Australian Governments meeting on Friday, evaluated three different policies for achieving the pledged reduction in emissions.

The first was one that would appeal to many environmentalists: extending the existing large-scale renewable energy target.

At present, the target is to achieve 33,000 gigawatt hours of renewable energy a year by 2020. To achieve our commitment under the Paris agreement, we'd have to more than double the target to 86,000 gigawatt hours a year by 2030.

The second approach was for a government regulator to work out which coal-fired power stations should be required to close down at which times, as renewable energy expanded.

You'd start with the oldest generators, including the particularly polluting brown coal generators.

The third approach was the one Turnbull rejected sight unseen: imposing an emissions intensity scheme on electricity generators.

You start by measuring the industry's present emissions intensity by dividing its total emissions of carbon dioxide in a year by its total production of electricity in the year.

This average becomes the industry's emissions intensity standard. Those generators operating above the standard have to get down to it by buying "credits" from those that are below it.

The standard is lowered – made more demanding – each year by the set amount needed to achieve the desired reduction in emissions.

See how it would work? The "dirtiest" generators – the coal-fired generators – also happen to be the ones whose electricity is cheapest to produce, whereas the cleanest producers – wind and solar – are the ones whose electricity is dearest.

So the cheap dirty generators are required to subsidise the expensive clean producers, thus creating a price incentive for the clean producers to expand and the dirty producers to contract.

It also means the overall price doesn't change much.

So how do the three approaches compare, according to the modelling done for the report – remembering that all modelling is built on a host of assumptions?

The extended renewable energy target turns out to be the worst approach. It leads to almost the biggest increase in the cost of electricity to consumers over the years to 2030.

It also has the highest cost per tonne of emissions reduced – $42 a throw.

This is because it doesn't allow businesses to pick the type of technology most appropriate to their needs. Dirtier brown coal would remain in the market for longer, while black coal and gas-fired generation were forced out.

Regulated closure of generators would cause the highest increase in prices to consumers, though its cost of emissions reduction is the second lowest - $19.50 a tonne.

The bureaucrats and politicians making decisions about which generators to close would have to get it right, avoiding the temptation to take account of political pressures and the interests of generous donors to party funds.

This leaves the emissions intensity scheme. It has the lowest effect on consumer prices relative to what the model assumes would happen to prices even if no attempt were made to reduce emissions.

It assumes consumer prices would still go up under "business as usual", but would rise by less under the intensity scheme.

It also has the lowest cost of reducing emissions – $17.50 a tonne.

So the option the formerly studious Turnbull rejected without considering is the best, and the one least likely to put prices up.

Well done, Malcolm. Especially as it's a safe bet Labor will be offering such a scheme at the next election.

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Politicised Treasury bites own tail, covers for Turnbull

Shadow treasurer Chris Bowen is right: One of the Abbott-Turnbull government's various acts of economic vandalism is its politicisation of the once-proud federal Treasury.

Among Tony Abbott's first acts upon becoming prime minister in 2013 was to sack the secretary to Treasury, Dr Martin Parkinson.

Even so, Parkinson was left in place for more than a year before being replaced by John Fraser, a retired funds manager, hand-picked by Abbott.

Fraser had risen through the ranks of Treasury under the formative influence of the legendary John Stone, until he left in the early 1990s to make his fortune in the money market.

When Fraser returned in triumph to take the top job, singing the praises of Margaret Thatcher, Ronald Reagan and David Cameron's austerity policy in Britain, it seemed clear he hadn't spent the intervening decades keeping up with developments in thinking about fiscal (budgetary) policy.

The Abbott government's next act of politicisation came a few months later with the publication of Treasury's fourth five-yearly intergenerational report.

It had been turned into a partisan propaganda rag, full of dubious figuring intended to prove the Abbott government's failure to return the budget to surplus as promised was all the fault of the previous Labor government. The media tossed the report aside.

The latest stage in the politicisation of Treasury came last week with its publication of a report on The Effectiveness of Federal Fiscal Policy, commissioned from Professor Tony Makin, of Griffith University.

If you've never heard of Makin's work, you'll be surprised to learn he regards fiscal policy as utterly ineffective and probably counterproductive.

If you have heard of it, you won't be. Makin's views on the ineffectiveness of fiscal "activism" – using budgetary stimulus to assist recovery during recessions – are well known, unchanged and unchanging.

He's the go-to guy for anyone who'd like an independent report asserting that fiscal policy doesn't work – never has and never could.

In all the decades since Makin made up his mind on this question, all the academic theorising and empirical evidence from the real world have served only to confirm the wisdom of that decision.

His paper's "review" starts by rubbishing that deluded fool John Maynard Keynes – who, presumably, will never attain the intellectual heights reached by Makin and his mates – and praising such giants of the profession as Robert Mundell, Marcus Fleming, Robert Lucas and Thomas Sargent.

It then reprises Makin's well-rehearsed argument that the Rudd government's budgetary stimulus – undertaken at the urging of the then Treasury secretary, Dr Ken Henry – was unnecessary and unhelpful.

And finally it does a lot of hand-wringing about the rapid growth in the public debt (especially when you exaggerate the size of the debt by quoting gross rather than net, a trick Makin seems to have learnt from Barnaby Joyce), the burden being left to our children, and the need to make reducing recurrent government spending our top fiscal priority.

One small problem – the last time Makin ran his anti-activism line, in a paper commissioned by the Minerals Council, Treasury issued a detailed refutation. Makin seems to have taken none of its substantive criticisms into account in his Treasury-commissioned version.

This is a measure of the extent to which politicisation has changed Treasury's tune.

Apart from correcting various factual errors, old Treasury noted that the 1960s-era Mundell-Fleming open economy model Makin uses relies on extreme assumptions that don't hold in Australia's case, and certainly didn't hold during the global financial crisis.

Makin is unimpressed that, at that time, such lightweights as the International Monetary Fund and the Organisation for Economic Co-operation and Development heaped praise on the Rudd government's budgetary stimulus.

So why has new Treasury chosen now to pay one of its former critics to repeat his ill-founded criticisms?

One reason is that Fraser left Treasury not long after it had advised the Hawke government not to use fiscal policy to respond to the severe recession of the early 1990s, but to rely solely on monetary policy (lower interest rates).

Henry and others in Treasury eventually realised how bad that advice had been. Indeed, Henry's advice to Rudd was influenced by a determination not to repeat the mistake. But Fraser had left the building by then and didn't read the memo.

Another reason is that, now, both the IMF and the OECD are urging the Turnbull government to help strengthen the economy by increasing its spending on worthwhile infrastructure.

What's more, some guy called Dr Philip Lowe has been saying the same thing. Forcefully.

Makin has been hired to tell these idiots they don't know what they're talking about.

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How to tell if recession looms

What would economic race-calling be without its little excitements? As you may possibly have heard, this week's news is that the economy has contracted - shrunk, gone backwards - by 0.5 per cent.

Oh, no! Another negative quarter will see the economy lapse into "technical" recession. Technically true, but quite unlikely - as almost all the money market economists had the honesty to admit.

If you're more practical than technical, and you live in Sydney or Melbourne, the best way to judge whether recession looms is to look out the window.

Bearing in mind that anyone under 25 has never seen a severe recession, and that anyone under about 40 probably wasn't paying much attention in 1991, let me give you a hint: they don't look anything like what you see around you.

What the self-styled experts on "technical recessions" don't tell you - perhaps because they don't know - is that employment is falling and unemployment climbing rapidly during actual recessions and even before the "technical recession" is proclaimed by a slavering media.

Think about it: rapidly climbing unemployment is the main reason those of us who've lived through a few recessions don't toss the word around lightly.

So what do we know about the employment story in Sydney and Melbourne?

According to the Bureau of Statistics monthly survey of the labour force, over the year to October total employment in NSW rose by 39,000, while the rate of unemployment fell by 0.6 percentage points to 4.9 per cent (although this was fully offset by a fall in the rate of participation in the labour force).

Not all that wonderful, but a long way from the precursor to a recession.

As for Victoria, it's performance is pretty good: total employment up by 109,000 over the year to October, with the unemployment rate down 0.3 percentage points to 5.7 per cent, even while the participation rate rose by 0.9 percentage points.

If you live in Perth, however, looking out your window would convince you the West Australian economy is in something like a recession.

Over just the six months to October, employment has fallen by 19,000 (1.4 per cent) while the unemployment rate rose 0.7 points to 6.4 per cent and the participation rate fell by 0.9 points.

Get it? If we were in or near recession, you wouldn't need the technical brigade to tell you.

The other point is that most of the weakness in the nationwide figures comes from the very tough times in the 15 per cent of the national economy represented by WA - which, of course, is bearing the brunt of the massive fall-off in mining and natural gas construction activity.

NSW and Victoria aren't doing too badly.

But why the sudden sharp contraction in the national figures? The bureau's national accounts for the September quarter show that the 0.5 per cent contraction lowered the economy's annual rate of growth to 1.8 per cent, down from 3.1 per cent over the year to June.

Michael Blythe, chief economist for the Commonwealth Bank, offers the most enlightening metaphor, saying the economy had just hit a pothole.

Paul Bloxham, his opposite number at the HSBC Bank, says the fall reflected an (unusual) accumulation of various one-off factors.

"First, export growth was weak, as coal production was disrupted by a roof collapse at a key mine, and various other factors," he says.

"Second, residential construction fell in the quarter, which the statistics bureau noted was due to inclement weather.

"Third, there was a sharp fall in public investment spending, which followed a sharp rise in the June quarter.

"Finally, mining investment continued to fall as projects are being completed."

It's clear the first three of these are just temporary setbacks. "Export growth is expected to bounce back strongly in coming quarters, given that there is substantial capacity still to come on line in the resources sector, particularly liquid natural gas export facilities," Bloxham says.

Exports of services rose in the September quarter and are expected to continue to rise, supported by demand from Asia.

In home building, there's a substantial pipeline of work yet to be done on new apartment projects, which should keep housing construction growing in coming quarters, although this will come to an end after that.

The sharp fall in public investment is unlikely to be repeated next quarter. Capital spending by the public sector is, to be technical, "lumpy" - it jumps around from quarter to quarter. In this case the figures were distorted by the privatisation of a big asset.

This is the 12th quarter in a row that business investment spending has fallen because of the end of the mining construction boom.

Since December quarter 2012, mining investment's share of gross domestic product has fallen from its peak of 9.4 per cent to 3.4 per cent.

This says we can't be far from the bottom, which is good news. Bloxham says mining investment should level out - and thus stop making negative contributions to growth - around the middle of next year.

Anything's possible, but a second negative quarter seems unlikely.

Even so, when you look behind all the one-offs, you do see signs in these accounts that the economy may not be growing quite as strongly as we formerly thought.

Growth in consumer spending has been on the weak side for two quarters in a row, even though the bureau's latest stab at the household saving ratio (as a proportion of household disposable income) says it's down to 6.3 per cent, quite a bit lower than we thought. Low growth in wage rates is taking its toll.

In November, the Reserve Bank's forecast showed the economy continuing to grow by about 3 per cent next year, strengthening to about 3.5 per cent by the end of 2018.

My guess is, when we see the revised forecast in February, it will be down a bit on that, though not by a lot.

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Why I'm a pathological optimist, in spite of my job

Last week in front of 1400 people at a Fairfax Media subscriber event I was outed as a "pathological optimist" by an anonymous reader, who wanted to know how I got that way.

It reminded me of Dylan Thomas, who went into a pub in America and got beaten up by some big bruiser – a future Trump voter, no doubt – for calling him heterosexual.

But, since you ask, I'll tell you – much as I hate talking about myself.

I think it's partly heredity, and partly by choice. When you grow up in the Salvos, professing to be "saved", it's natural to be happy with life and confident Someone Upstairs will look after you.

My mother was an incessant worrier and I grew up seeing her worrying about a lot problems that never eventuated. My father wasn't a worrier. I decided to take after my dad.

In truth, as optimists go I'm out and proud.

I can only guess at what the future holds, but people are always asking for my prediction.

If you want a forecast that errs on the optimistic side, I'm your man. If you want death and destruction, feel free to take your business elsewhere.

Many people switch between economic optimism and pessimism depending on whether they approve of the present government. Not me.

Of course, if I thought we were staring recession in the face I'd say so. Even if I thought the possibility was a lot higher than normal I'd say so – though I'd keep the announcement sober rather than sensational.

Most of the time, however, the safest and most likely prediction is that next year will be much the same as this year. When it's a half full/half empty choice, you know which way I'll jump. (You know, too, that an economist is someone who thinks the glass is twice as big as it needs to be.)

What I said at that event last week was that I'm an optimist because "it's easier to get through life that way".

It's true. I commend it to you. And I have scientific proof. Professor Martin Seligman, of the University of Pennsylvania, a founder of the positive psychology school and author of Learned Optimism, has written that optimism and hope are quite well-understood, having been the object of thousands of empirical studies.

They "cause better resistance to depression when bad events strike, better performance at work, particularly in challenging jobs, and better physical health".

Other research has shown that individuals who profess pessimistic explanations for life events have poorer physical health, are prone to depression, have a less adequately functioning immune system and are more frequent users of medical and mental healthcare.

A study by Toshihiko Maruta and others at the Mayo Clinic, which followed almost 450 patients over 30 years, found that optimists lived longer than pessimists and reported better physical and mental health. Wellness is attitudinal, not just physical.

My conclusion is that optimists live happier lives than pessimists. But are optimists happier people or are happy people more optimistic? Bit of both, is my guess.

Which is not to say optimism is rational or realistic. It isn't. Seligman defines optimism as a style of explaining life events.

Pessimists think the bad things that happen to them are permanent ("the boss is a bastard") whereas optimists think they're temporary ("the boss is in a bad mood").

Pessimists think the good things that happen to them are temporary ("my lucky day") whereas optimists think they're permanent ("I'm always lucky").

Pessimists have universal explanations for their failures ("I'm repulsive") whereas optimists have specific explanations ("I'm repulsive to him").

But don't knock self-deluding optimism. It's a motivating force for innovation and entrepreneurial endeavour and it keeps the capitalist system turning.

Business people invent new gismos and launch new products because they're convinced the new thing will be hugely successful, making their name and fortune.

Few succeed. Most do their dough. But the ones who do succeed make us more prosperous than we were. Then they try again.

But I confess my optimism is part professional calculation. As a commentator I have a contrarian streak. When all my competitors are saying black, I look for a way to say white.

This isn't hard or contrived because the media have an inbuilt tendency to predict the worse, believing this will please the audience and make them more popular.

Journalists believe our audience finds bad news more interesting than good news. For sound evolutionary reasons I've discussed before, this is right.

But ever intensifying competition has prompted the media to go over the top in their search for the big and bad.

Trouble is, most readers are optimists like me. They want to sustain their belief that, despite the bad things happening, the world is still fundamentally good, Australians are basically decent people despite some recent lapses, and life will get better, not worse.

I fear the bad-worse-worst news formula may be too depressing for some people, prompting them to switch to Facebook and photos of their friends' latest holiday.

If that's how you feel, dear reader, I'm here to help.

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Education efficiency should start with Grattan compromise

If Treasury wants to start acting more like economists than accountants, a good place to start would be to urge its political masters to seize on the opportunity presented by the school funding "compact" proposed by the Grattan Institute.

Treasury advice would be much improved if it switched its approach to the budget from helping the politicians cook up some quick cuts to government spending to a more medium-term focus on achieving better value for the taxpayers' dollar through greater efficiency and effectiveness.

A more medium-term approach allows greater scope for micro-economic considerations to be incorporated into decision making.

The policy quagmire of school education is crying out for Treasury's guiding hand. It's hard to believe that school funding is still dogged by century-old sectarian rivalry between the public, Catholic systemic and independent school systems.

Thanks to this unending rivalry, the nation spends almost all its time arguing over how public funding is shared between the three systems, leaving little time to debate how well the money's being spent and how it could be better spent.

Meanwhile, domestic performance measures (NAPLAN) show, at best, no improvement in our performance over time, and international measures (PISA) show other countries improving while we mark time.

Our results show a wide gap between our best and worst performing students, which hasn't changed much, neither because our best have got better nor because our worst have got less worse.

Is this something Treasury is happy to see roll on? One unlikely to have much adverse effect on either the budget balance or national productivity?

Well, if we keep putting most of our energy into public versus Catholic versus independent, rest assured it will.

The Gonski funding review came up with a breakthrough proposal to rise above sectarian squabbling by moving to the division of combined federal and state funding on the basis of student need, regardless of which silo a disadvantaged student was in.

The Gillard government belatedly introduced a bastardised and far more expensive version of "Gonski", which the Abbott government pretended to support but disavowed immediately on winning office.

So the sectarian standoff remains. The Coalition isn't prepared to implement Labor's version of Gonski because it's too expensive, but it's too expensive because of Labor's promise to help the poor schools (those with many disadvantaged students) at no cost to the rich schools (those with few disadvantaged students).

Trouble is, until we direct more funds to the disadvantaged students, we don't stand much hope of improving our schooling outcomes.

Of course, a more efficient allocation of funds is just the first step towards improving the outcomes of disadvantaged students –  which is why it's so important to move the debate on from how the money's divided to how effectively it's being spent.

Clearly, moving to needs-based funding is as much about efficiency as about equity (fairness).

It makes zero economic sense to continue overfunding some students while those you underfund become an underclass of poorly educated workers who spend a lifetime in and out of employment, making a weak contribution to national productivity (not to mention being a recurring drag on the budget).

The 2014 budget did nothing to correct the maldistribution of federal funding to public and private schools, it just cut the basis of annual indexation from a high rate set by the Gillard legislation to just the consumer price index (much less than the rise in teachers' wages). It was about cost shifting, not reform.

This was always unsustainable politically. In the end, Malcolm Turnbull relented and promised to keep the original funding arrangement going for another three years to 2020.

Turns out grants are set to grow by 3.6 per cent a year, whereas teachers' salaries are more likely to grow by 2.5 per cent.

The genius of the "circuit-breaking new compact" proposed by Peter Goss and Julie Sonnemann of the Grattan Institute is that it seizes this rare chance to propose a deal that would get all schools up to 95 per cent of needs-based funding (the "schooling resources standard") by 2023, much earlier even than Gillard's plan.

This would involve schools below the 95 per cent benchmark having their funds raised by 3.6 per cent a year, while those between 95 and 100 per cent of the standard would rise by 2.5 per cent and those already above the standard would mark time.

This last element is the compact's point of political vulnerability, of course, and already Labor has found it.

Put the Labor opposition's personal ambitions ahead of the interests of disadvantaged students? Why not, says Labor's spokeswoman, the not so lovely Tanya Plibersek.

Let's hope Treasury has higher principles than Labor.

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Many guesses why productivity may have stopped improving

Conventional economics is falling apart, no longer making the sense we thought it made. Economists are entering a period of puzzlement and uncertainty, while their high priests struggle to hold the show together.

You can tell all that if you read between the lines of the Productivity Commission's discussion paper launching its inquiry into Increasing Australia's future prosperity, published last month.

It’s meant to be the first five-yearly review of our productivity performance, the micro-economic equivalent of Treasury’s (misnamed and now politically hijacked) five-yearly macro-economic intergenerational reports.

So it has potential to be a big deal. If you missed hearing about the discussion paper it may be because it was overshadowed that week by something that happened to a Mr Trump.

The commission opens its discussion with the alarming observation that "there is a justified global anxiety that growth in productivity – and the growth in national income that is inextricably linked to it over the longer term – has slowed or stopped".

Productivity is a measure of an economy's (or a business's) ability to convert inputs of resources into outputs of goods and services.

We commonly (and least inaccurately) measure it as output per unit of labour input – per worker or per hour worked.

But the commission prefers to measure it as output per unit of both labour and capital inputs, which it calls "multi-factor productivity". This is intended to be a measure of the essence of productivity improvement: technological advance and increased human capital.

Trouble is, the commission says, "since 2004, multi-factor productivity has stalled, here and around the developed world. This is a long enough period to suggest something is seriously awry in the economic fundamentals and the consequent generation of national wealth and individual opportunity."

Actually, by the commission's own figuring, Australia's labour productivity in the "12-industry market economy" improved by 1.9 per cent in 2014-15, the most recent year available, and our multi-factor productivity improved by 0.8 per cent, which was also our average rate of multi-factor improvement over the previous 40 years.

It's true, however, that our multi-factor performance has looked pretty sick since the turn of the century.

But the first point to note is that the problem is global, not just some weakness of ours – a fact a lot of those who've used our weak numbers to push their own favoured "reforms" have often failed to mention.

Next point, which is also often not mentioned: economists can't measure multi-factor productivity with even remote accuracy. That's mainly because they can only guess at the contribution one unit of physical capital (whatever that is) makes to production.

So it's hard to be sure the weak multi-factor productivity figures most developed countries are producing are real.

Next, assuming they are real, economists can only guess at the factors causing them. There's a lot of guessing going on by some of the world's top economists, but as yet there are no policy changes we could make with any confidence that they'd fix the problem.

Our eponymous commission produces an annual update on our productivity figures but, though it's been wringing its hands for years, its analysis has never once been able to put its finger on a causal factor we could do something about.

The few explanations it's found are either temporary or nothing to worry about.

The discussion paper acknowledges, but then dismisses, the argument of those wondering if the whole "problem" is merely a product of monumental mismeasurement.

I don't dismiss it. Had the economists not assured us of the opposite, most of us would look at the wonders of the digital revolution and the many industries being hit by digital disruption and assume the productivity indicators must be going gangbusters.

How can we be sure they aren't? One of our most thoughtful economists – one who's always gloried in digital advances – is professor John Quiggin, of the University of Queensland.

Quiggin argues that the economists' conventional model for thinking about the economy and how it grows is based on an industrial economy, which made sense in the 19th and 20th centuries, but is becoming increasingly outmoded and misleading.

We focus hard on the production of goods – agriculture, mining and manufacturing – but are vaguer about the production of services, which is the main part of the economy that's growing.

Today, he says, the primary engine of economic development is information, but information has radically different characteristics to a physical good or a service such as a haircut.

Information is often free ("non-excludable", as economists say) and it can't be used up ("non-rivalrous").

This outdated, industrial-age way of thinking about growth and productivity is reflected in the way we define and measure the economy and productivity via gross domestic product.

For instance, we measure only economic activity in markets, meaning we exclude all the activity taking place in households, and can't measure the productivity of the 20 per cent of GDP created in the public sector, including such minor industries as health and education.

And we ignore one of the most valuable outcomes of the greater prosperity that is the Productivity Commission's god: hours of leisure.

None of this, however, will stop the commission using its ultimate report to advocate a bunch of "reforms" intended to improve our small corner of the world's alleged productivity problem.

As we speak, Canberra's second biggest industry – the lobbyists – are busy churning out their self-interested submissions to the inquiry, advocating such radical new ideas as cutting company tax and weekend penalty rates.

To be fair, the commission says it's "particularly interested in new and novel ideas because there is already a strong awareness of many reform options that parties would like to see implemented. More of the same is not likely to be helpful."

We'll see how far it gets with that fond hope.

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OVERVIEW OF THE AUSTRALIAN ECONOMY

Talk to Economics Teachers Association of WA, Perth, Friday, December 2, 2016

The theme for your conference, Economic Cycles - Riding the Waves, is particularly well chosen. At a time when Western Australia is well and truly in the downswing of its cycle, the national economy is celebrating have completed 25 years of continuous growth, a record for our economy and something no other developed economy has achieved in the same period. I’ll leave it to Nicky Cusworth to look closely at the ups and downs of the WA economy, but how can we say the national economy is sailing along while WA is making such heavy weather of it? Because, as the RBA’s chief economist, Dr Chris Kent, reminded us last week in a speech that’s well worth West Australians looking up,

http://www.rba.gov.au/speeches/2016/sp-ag-2016-11-22.html#r10

the national economy is just the weighted average of the six state and two territory economies. And whereas a few years back the mining states, WA and Queensland, were riding high and NSW and Victoria were doing it tough, the end of the boom has seen those roles reversed.

Why we’ve gone 25 years without a severe recession

I’ll say no more about that, but switch the focus back to the national economy and the question of how we’ve been able to keep the economy growing for so long. A lot of people think the answer is obvious: China has kept us going. But that’s wrong. For one thing, the resources boom didn’t start till about 2003, roughly half way through the 25 year period. More fundamentally, giving all the credit to China reveals an ignorance of the way economies move in cycles. You can say that China’s resources boom added greatly to the amount of economic growth over the period, but it’s a strange argument to say that introducing a huge boom and bust - first, in coal and iron ore prices and then in mining and natural gas construction activity - explains why the economy has never contracted in 25 years, even though, before that - and still in other developed economies - recessions are usually about seven years apart. To put it another way, economies rarely drop into recession just because they’ve run out of puff. They usually do it because someone jammed on the brakes too hard. And they usually jam on the brakes because they’re reacting to a boom they’ve let run away and become too inflationary.

As the RBA governor, Dr Phil Lowe, remarked in one of his recent speeches, our 25-year expansion is the more remarkable when you remember the major “economic shocks” that hit our economy during the period and could have knocked us off track the way they did many other countries: the Asian financial crisis of 1997-98, the US Tech Wreck of 2001 and the global financial crisis of 2008.

So why didn’t they? More because of our good management than our good luck. The microeconomic reforms of the 1980s and 1990s made the economy more flexible - better able to roll with the punches from economic shocks - and thus less inflation-prone and unemployment-prone. The reduction of protection and the floating of the dollar made our industries more open to competition from imports, while deregulation heightened competition between domestic players. Increased competition - including in the provision of utilities - also reduced cost-push inflation pressure by reducing the pricing power of some industries and their unions. The move from centralised wage-fixing to collective bargaining at the enterprise level reduced the risk of excessive wage increases and, as we saw in the wake of the GFC, reduced the tendency of employers to respond to downturns with mass layoffs.

A more flexible, less-inflation prone economy is one that’s easier for the macro managers to keep stable. But we’ve see reforms also at the macro-economic level with the establishment of formal “frameworks” for the way fiscal policy and, more notably, monetary policy should be conducted. Monetary policy decisions are now made by the RBA independent of the elected government, and in accordance with the medium-term inflation target.

You can see how the macro stabilisation task benefits both from the greater flexibility arising from micro reforms and from the more deft use of the macro policy arms arising from the introduction of “frameworks” in the way we handled the biggest economic shock to hit our economy since the Gold Rush, the resources boom. Previous commodity price booms to hit our economy have led to inflation surges, followed by belated corrective action, followed by busts and recessions. Knowing this, the econocrats went to great lengths to ensure it didn’t happen this time. In this they were greatly assisted by the move to a floating exchange rate. Rather than having to wait too long while the government accepted the need for revaluation, the floating rate appreciated immediately and significantly in response to the increase in export prices. One effect of this was to shift some of the benefit of the improvement in our terms of trade away from the mining companies to all those businesses and consumers who bought imports. But another effect of the high dollar was to reduce the demand for tradable goods and services - such as manufactures, tourism and international education - thus making it easier for resources to shift from the contracting sectors to the expanding mining sector without great inflation pressure. Decentralised wage fixing, plus the use of temporary 457 visas, kept the rise in mining sector wages from spreading to wages everywhere. The result of all this was that the resources boom’s potential inflation pressure was contained, but at the expense of weaker growth in the non-mining states.

By now, as you well know, the price and construction phases of the resources boom have come to an end and, although the increased-production phase has further to run, the economy has been making a transition from mining-led growth to growth led by other parts of the economy. Growth in the non-mining economy is being stimulated by a very expansionary stance of monetary policy and by a large fall in the dollar (in belated response to the fall in export prices and deterioration in the terms of trade), although we’re not getting much help from slowing growth in China, moderate growth in the United States and weak growth in Japan and Europe.

Recent record and outlook for the economy

We’ll get another reading from the national accounts next week, but previous quarters show real GDP growing at the rate of 3 per cent - which, as we’ll see, is just a fraction faster than our “potential” growth rate. The RBA’s most recent forecasts show the economy continuing to grow at about 3 per cent next year, strengthening to about 3.5 per cent by the end of 2018. This would involve inflation gradually returning to the 2 to 3 per cent target range. The unemployment rate should improve only marginally, with the labour market weaker than it seems from looking just at the level of the official unemployment rate.

If you find that hard to believe, the explanation is simple: most of the growth is coming from NSW and Victoria (which account for 55 per cent of the national economy), with most of the weakness coming from WA (accounting for less than 15 per cent) and mixed performances in Queensland, SA and Tasmania. The NSW economy is growing so strongly it even has strong growth in non-mining business investment; which is going backwards in WA. The RBA estimates we are about 80 per cent of the way through the decline in mining investment as the pipeline empties out.

Australia’s lower potential growth rate

Australia’s present and prospective rate of economic growth is lower than we experienced in earlier years. This is partly for cyclical reasons - the continuing transition from the resources boom, especially in WA - but also for longer-lasting structural reasons. You can see this in the way the econocrats have been revising down their estimate of our “potential” growth rate. Our potential growth rate is determined by the supply-side of the economy, rather than the demand side. It is the average rate of growth in the economy’s capacity to produce goods and services over the medium term. It can be raised by growth in the labour force, growth in investment in business equipment and infrastructure and improvement in productivity. Once the economy is operating at full capacity utilisation - full employment - our potential growth rate sets the speed limit at which the economy can grow without excessive inflation. But while the economy is operating with spare production capacity - that is, while it has a negative “output gap” - it can grow at rates exceeding the potential rate without worsening inflation.

An economy’s output gap is a measure of the extent of its spare production capacity. Where its actual rate of growth is lower than its potential growth rate, the difference contributes to a negative output gap. Where the actual rate of growth is higher than the potential rate of growth, and economy is at full employment, the difference is a positive output gap, which will be causing inflation pressure to build. Note that, because the economy’s ability to produce goods and services gets a bit bigger almost every year, potential is a rate of growth.  By contrast, the output gap is a level, an absolute amount - the deference between one level of GDP and another level.

It’s hard to calculate an economy’s potential growth rate (or, for that matter, its NAIRU - non-accelerating-inflation rate of unemployment) with any degree of certainty. And the rate will change over time as the factors affecting it change. For a long time Australia’s potential rate - often referred to as our (forward-looking) “trend” rate of growth - was taken to be 3.25 per cent a year. But then this was lowered to 3 per cent and last year it was cut further to 2.75 per cent. Why? Because of slower population growth since the end of the resources investment boom, because the retirement of the baby boomers is lowering the labour force participation rate (only partly offset by the trend to later retirement) and because, as is true for all the developed economies, Australia’s rate of productivity growth is lower than it used to be.

It’s roughly estimated that, because of many years of weak growth until the past year or so, our negative output gap is equivalent to about 1.5 per cent of GDP. That is, actual growth could be a cumulative 1.5 percentage points higher than the potential rate before we reached full capacity and had to slow down to the potential rate to avoid excessive inflation. But each year that we grow by more than 2.75 per cent will take up spare capacity and reduce the output gap.

Now let’s turn to recent developments in the management of the macro economy using monetary policy and fiscal policy, starting with monetary.

Monetary policy

Monetary policy - the manipulation of interest rates to influence the strength of demand - is conducted by the RBA independent of the elected government. It is the primary instrument by which the managers of the economy pursue internal balance - low inflation and low unemployment. MP is conducted in accordance with the inflation target: to hold the inflation rate between 2 and 3 pc, on average, over the medium term. The primary instrument of MP is the overnight cash rate, which the RBA controls via market operations.

The RBA cut the official interest rate hard in response to the GFC in 2008, but then put rates back up once it became clear a serious recession had been averted.

In November 2011, the Reserve decided the resources boom was easing and would not push up inflation. It realised growth in the non-mining sector of the economy was weak - held down particularly by the dollar’s failure to fall back in line with the fall in export prices – at a time when mining-driven growth was about to weaken. So it began cutting the cash rate, getting it down to a historic low of 2.5 per cent by August 2013.

For the next 18 months the Reserve sat back and waited for this very low interest rate work through the economy and have its effect. Not all that much happened, with the economy continuing to grow at a below-trend rate. The dollar did start falling in the first half of 2013, and by June 2015 it had dropped to about US77 cents (from its peak of US1.10 in mid-2011), but this would have been explained much more by the continuing fall in coal and iron ore export prices than by our lower interest rates relative those in the major advanced economies. The Reserve continued to note that the exchange rate hadn’t fallen by as much as the fall in commodity prices implied it should have, explaining this as a consequence of the major advanced economies’ resort to “quantitative easing” (money creation), whose main stimulatory effect on their economies came by forcing their exchange rates lower (thus causing ours to be higher than otherwise).

So in February 2015, after a gap of 18 months, the Reserve resumed cutting rates, dropping the official rate another notch, and again in May, to reach a new low of just 2 pc. It resumed cutting a year later, in May 2016, and then by another notch in August, taking the cash rate to a new record low of 1.5 per cent. There is little reason to doubt that the total fall of 3.75 percentage points since November 2011 has helped to hasten growth the non-mining sector of the economy. In particular, it prompted the boom in the housing market, causing big increases in house prices and new home building, particularly in Sydney and Melbourne. How much the lower rates contributed to the fall in the exchange rate is debatable.

The further rate cuts in 2016 were made possible by the weakness in inflation and wages growth, with the inflation rate falling short of the target range. It’s doubtful whether the Reserve expects the recent cuts to do much to encourage borrowing and spending. More likely it is hoping that lowering our rates - which are still high relative to rates in the major economies - will exert some downward pressure on our exchange rate, thus improving the international price competitiveness of our export and import-competing industries. In his final speech, retiring Reserve governor Glenn Stevens acknowledged that the effectiveness of monetary has been reduced by the already-high debt level of Australian households, which has limited their willingness to borrow more so as to spend more - the main mechanism by which lower interests stimulate demand. Mr Stevens noted that Australia’s households are far more heavily indebted than our government, arguing that, if further policy stimulus is needed, it should come from fiscal policy: increased public borrowing and spending, provided this spending is on useful infrastructure rather than recurrent expenses.

Fiscal policy

Fiscal policy - the manipulation of government spending and taxation in the budget - is conducted according to the Turnbull government’s medium-term fiscal strategy: “to achieve budget surpluses, on average, over the medium term”. This means the primary role of discretionary fiscal policy is to achieve “fiscal sustainability” - that is, to ensure we don’t build up an unsustainable level of public debt. However, the strategy leaves room for the budget’s automatic stabilisers to be unrestrained in assisting monetary policy in pursuing internal balance. It also leaves room for discretionary fiscal policy to be used to stimulate the economy and thus help monetary policy manage demand, in exceptional circumstances - such as the GFC - provided the stimulus measures are temporary.

The Abbott government’s first budget, in 2014, set out a program of largely delayed measures to return the budget to surplus over a number of years. The measures focused heavily on cutting spending programs of benefit to low and middle-income families, ignoring the many overly generous tax concessions on superannuation, negative gearing and capital gains tax, whose benefits go predominantly to high income-earners. Because many of the spending cuts were contrary to Mr Abbott’s election promises, and many were judged to be unfair, the budget caused a plunge in the Abbott government’s popularity, from which it never recovered. Many of its cuts were blocked in the Senate.

The Abbott government’s second budget, in 2015, made little further attempt to reduce the budget deficit and seemed to focus mainly on measures intended to restore the government’s standing in the opinion polls. The deficit in 2015-16 was twice the size of the deficit in 2012-13.

The Turnbull government’s first budget, in 2016, attempted to do no more than hold the line on the deficit while it introduced a package of tax reform measures. It propose a minor cut in income tax, but its centrepiece was a plan to cut the rate of company tax from 30 to 25 per cent, phased in over 10 years. To help cover the cost of this cut, the budget sought to increase taxes in three main ways: by big increases in the tax on tobacco, a very worthwhile reduction in superannuation tax concessions and a serious crackdown on tax avoidance by multinational companies. The government is likely to have more success in getting these tax increases through the Senate than its cuts in company tax for big business. If so, its budget may end up making a useful contribution to reducing the budget deficit.

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The Game of Mates we never quite notice

Not long after he arrived at Sydney Cove as a convict on the First Fleet, James Ruse was granted Australia's first parcel of private land – 30 acres in the heart of Parramatta – by governor Arthur Phillip.

Establishing private property rights in land is one of the core powers of government to this day. Britain had imposed limits on how much land Phillip could give away, but he had discretion over who he gave it to.

He seems to have taken a shine to Ruse, or maybe Ruse knew how to keep in his good books.

Three years later, Ruse sold his original grant for £40. A year later he was given 140 acres. Then another 16 acres, three years later.

The following year he sold these lands for £300. Twenty-one years later, aged 60, he obtained another grant of 100 acres at Riverstone. Altogether, he was given land value equivalent to about 20 years' wages for an English worker. In today's terms, about $1.5 million.

All this is recounted in the book, Game of Mates: New Masters of Australia, by Paul Frijters and Cameron Murray, to be launched on Friday.

Frijters, one of the most promising academic economists in the country, was a professor at the University of Queensland, but some of his research mightily offended the Brisbane establishment, so now he's off to a better job at the London School of Economics.

The book is his parting gift to Australia. He argues that a small class of well-connected operators hanging around the levers of government power are lining their own pockets at the expense of the rest of us.

Since Ruse was the first of them, he names each of these villains James. Frijters wants us to meet his archetypal modern James.

"He is a charming Queenslander who went to the right school, was president of the student union and has both politicians and top civil servants in his contact list. He is a professional in the Game of Mates.

"James is a clever man. When the 1980s housing boom began driving up the prices of houses throughout Queensland, he pinpointed a way to leverage the price gains for himself."

James' genius was to recognise that politicians and bureaucrats were truly in control of the gains from the influx of money for housing.

"It took political decisions to decide where new houses could be built. It took bureaucratic decisions to decide who would get permission to build bigger houses and larger apartment buildings.

"James set to work, using some of the money from his family's wealth to get started. He bought large plots of land just where one would not think the cities would expand and he set to work on the politicians and bureaucrats he knew.

"He spent time with them, shared parties and business dealings with them. He made some of them partners in his firm and, in turn, James' friends were appointed on boards deciding on planning decisions.

"Befriended politicians ran with slogans pronouncing that James' wishes were opportunities for their region, rather than costs to it.

"The politicians were later rewarded with consulting jobs to James and his friends' companies."

Get it? A Game of Mates doing what mates do, look after each other. I do you a favour and maybe one day you'll do me one.

Frijters argues this game is played in many more areas than land zoning. It can be played wherever government departments are supposedly regulating the activities of powerful industries in the interests of the public.

How many times have we seen politicians and top bureaucrats retire, but then pop up a few months later on the board or as a consultant to one of the companies they used to regulate?

How many times have we seen lobbyists brought in to head departments that regulate particular industries?

Frijters says the game has four main elements. First, flaws in our laws and regulations that create an economic honeypot to be snatched.

Second, the need for James and his mates to work as a group to capitalise on these flaws by establishing their networks of favour-exchanges.

Third, they need a way to signal loyalty to the group, a way for new members to join, and a way to rid themselves of traitors.

Fourth, they need to shield their true actions from public scrutiny with plausible myths suggesting James' dodgy dealings are good for Australia.

Frijters stresses that people playing this game aren't necessarily acting illegally, and in that sense may not be corrupt.

"The rules surrounding conflicts of interest, cooling-off periods for politicians [before they begin] working in industry, and exercising political discretion, are weak in Australia," he says.

What can we do to stop the game? "Our basic advice is to charge James for the privileges he trades in his Game of Mates or to establish a public competitor to supply the product he sells ourselves.

"We should charge him for the value increase on his houses. Charge his bank for the profits made by collusion, or introduce real competition by a true state bank. Charge his mines for the value pumped out of our ground. Charge him proper taxes. Set up a state superannuation fund . . . to compete with private ones."

Just as well you're leaving the country, Paul.

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Smarter thinking on budget is long overdue

I've been writing about the federal budget for 43 years, for 28 of which it's been in deficit.

So almost two-thirds of my career has been spent backing up Treasury in its recurring campaigns to pressure the government of the day to get the budget back to surplus. Sorry, not any more.

I've resigned from the budget-hectoring brigade because it finally dawned on me there has to be a better way.

You can put the blame for our eternally recurring budget crisis on the voters, whose demand for increased government spending is limitless, but whose willingness to countenance either spending cuts or tax increases is tiny.

Or you can blame the pollies – on both sides – who spend every election campaign pandering to and thus reinforcing this unreal thinking.

They wait until after elections to spring the bad news about the laws of arithmetic, then wonder why it's so hard to be economically responsible.

But I think some of the blame has to be shared with Treasury and Finance. It's true that treasuries – state as well as federal – accept ultimate responsibility for getting the budget back to balance. They care about budget balance above all other policy objectives.

Which is just as well. If Treasury didn't accept ultimate responsibility for fiscal rectitude, who do you reckon would? Certainly not the politicians, nor the media, nor the electorate.

That's why for so long I was happy to throw my puny weight behind Treasury's budget-repair campaigns.

I've stopped because, in all that time, there's been no sign of a learning curve. Treasury goes about attempting repair of the budget in just the same primitive way it did in the mid-1970s.

In all that time it's learnt almost no new tricks. It's applied no new science to its core responsibility of expenditure control, just kept on with the same old, same old simplistic cost-cutting approach.

Economists elsewhere have come up with inventive ways to make government spending more efficient and cost-effective: income contingent loans, activity-based health funding, the investment approach to welfare spending, early learning and other preventive programs, rigorous program evaluation and more.

Some of these techniques are being used in the federal budget, but not to the extent they should be and, to my knowledge, not because they were long championed by Treasury and Finance.

Indeed, it wouldn't surprise me if some had been opposed, or long-term investment in preventive medical programs sabotaged for a quick saving.

The best Treasury has come up with is the Orwellian annual "efficiency" dividend imposed on departments and agencies, and the rule that departments proposing new spending programs must also propose offsetting spending cuts of equivalent value.

Both crude devices have been relied on year after year, to the point where their economies are more likely to be false ones.

The efficiency dividend has become a euphemism for indiscriminate compulsory redundancies, which has robbed Treasury and Finance, and even the spending departments, of many of their policy experts.

Not to worry. If we need policy advice we'll buy it from one of the big accounting firms. They'll pretend to know what they're talking about and cost a fortune, but can be relied on to give us the recommendations we were hoping for.

The offsetting-savings rule has turned inefficiencies into valuable currency, to be husbanded jealously by their departments and given up only in return for equivalent spending increases.

It transfers responsibility for finding efficiencies away from the co-ordinating departments and into hands of departments just as likely to have been captured by the business interests they're supposed to be regulating.

The accountants of Finance can hardly be blamed for thinking like accountants. Trouble is, Treasury people too often think and act like accountants rather than economists.

They tend to view spending control as an annual scramble to knock the budget into shape, not a medium-term exercise in delivering value for money to the citizenry the government serves.

Too often they fail to consider the broader economic consequences of the cuts they push through. Like accountants, they think in terms of chopping spending down to the required size, not improving the efficiency and effectiveness of government service delivery.

They bang on about the nation's poor rate of productivity improvement while forgetting they themselves possess considerable scope to raise the efficiency of two of the economy's biggest and fastest growing industries, the two spending areas that dominate combined federal and state budgets and that will, unless made more efficient, do most keep budgets in crisis for decades to come: education and health.

No, no, leave that to the departments – or the other level of government.

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Reduced competition may be slowing US growth

US financial markets may be betting that the Trump administration's budget policies will stimulate economic growth and inflation, but they're cheered by this prospect only because of deeper fears that America and the advanced economies have entered an era of persistently weak growth.

America's rate of growth has been slowing for decades, starting long before the onset of the global financial crisis.

As part of this, America's rate of productivity improvement has been weakening, despite a short-lived uptick in the 1990s.

So the hunt's been on for factors that may be causing this slowdown. There are many suspects. But one you often see mentioned by economists such as Professor Paul Krugman is a decline in the strength of competition in many American markets.

If markets are significantly less competitive, you'd expect this to mean consumer prices that are higher than they might be, profits that are higher, less innovation, slower productivity improvement, worsening inequality and slower growth.

But what's the evidence of reduced competitive pressure? Earlier this year President Obama's Council of Economic Advisers issued a paper reviewing the evidence, which I'll summarise.

There are various ways to measure the degree of "concentration" in an industry – that is, how much of the business done by an industry is captured by a small number of large firms.

Figures collected by the US Census Bureau show that, over the 15 years to 2012, the share of total sales revenue earned by the 50 largest firms in 13 broad industry categories fell in three, was unchanged in one but increased in nine.

If 50 sounds like a lot of firms, remember this is America, whose economy is about 12 times bigger than ours.

Sales concentration was highest among utilities – electricity, gas and water – at 69 per cent, which isn't surprising considering many are natural monopolies. Even so, concentration increased by almost 5 percentage points.

After that came finance and insurance, where concentration was up by 10 percentage points to more than 48 per cent, followed by transportation and warehousing (up more than 11 points to 42 per cent) and retail trade (up 11 points to 37 per cent).

This picture is confirmed by studies of specific industries, the briefing paper says. One study of the national market for loans found that, over the 30 years to 2010, the top 10 banks' market share increased by 20 points to 50 per cent.

For deposits, the market share increased from 20 per cent to almost 50 per cent.

Another study found that, for hospital markets over the decade to 2006, a common measure of concentration increased by about 50 per cent, to a degree equivalent to having just three equal-sized competitors in a market.

A different measure of possibly reduced competition comes from looking at what's happened to the rates of profitability of big firms.

When researchers take the rates of return on invested capital for listed US companies, then rank them from highest to lowest, they find that for firms at the 90th percentile (that is, 10 per cent down from the top; 90 per cent up from the bottom) their rate of return is five times higher than for the median (dead middle) firms.

A quarter of a century ago, the 90th percentile firms' rate of return was closer to twice the median firms'.

This suggests some firms are better able to extract "economic rent" than they were. Economic rent is the profit you make that exceeds what you'd need to earn to be willing to remain in the industry.

Yet another indication comes from the "long-term downward trend in business dynamism", as indicated by a steady decline since the late 1970s in the proportion of new firms entering markets each year.

This is while the proportion of firms exiting markets each year has been little changed. Since the entry rate has now fallen to be equal to the exit rate, the total number of firms – which used to grow by about 6 per cent a year – is now unchanging.

Part of the explanation for the decline in the number of new firms could be rising "barriers to entry" into many industries.

This could be caused by increased federal, state or local licensing requirements, ever-rising economies of scale or data-mining information advantages to incumbent firms, or successful lobbying for government rules to protect against new entrants.

Labour market dynamism – how often workers change employers – has also declined since the 1970s.

This could have many causes, including no-poaching agreements between employers and greatly increased occupational licensing, which limits people's freedom to move between states.

The briefing paper notes it's not yet clear how these various indicators suggesting the US may be suffering a fall in competition within its markets fit together.

Turning to possible causes of reduced competition, it notes the problem of "common ownership". Researchers have argued that institutional investors who are large owners of the biggest firms in a particular industry, implicitly encourage those firms not to compete with each other, thus raising the investors' profits.

According to other research, the role of institutional investors has grown over the past 30 years so that, in 2014, they controlled 61 per cent of worldwide investment assets.

One anti-competitive development the briefing paper doesn't mention is the US Congress's willingness to keep extending the lives of existing and future patents and copyright.

Meanwhile, US government trade negotiators use bilateral preferential trade deals – going by the Orwellian name of "free trade agreements" – and plurilateral deals such as the Trans-Pacific Partnership agreement to press partners like us to extend the lives of our patents and copyright to fit with the Yanks' domestic arrangements.

Maybe one reason economic growth is slowing is that the world's multinational corporations are getting too good at finding ways to inhibit competition between them, including by enlisting the help of governments.

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'Nanny state' is cover for exploitation by commercial interests

Oh no, the nanny state brigade is at it again. In their certainty they know what's best for us, they're back with their social engineering, wanting to punish us for being fat and use a tax on sugary drinks to push us towards "healthier choices".

On Wednesday the Grattan Institute will release a report urging the federal government to impose an excise of 40¢ per 100 grams of sugar on non-alcoholic beverages that contain added sugar.

What part of personal freedom don't they understand? If people want to drink sugary drinks, why should anyone else try to stop them? What harm are they doing to others?

Surely this is a matter of personal choice and responsibility. If being fat is bad for the health, it's up to the individual to accept responsibility for their own fate and decide to eat less and exercise more.

How much of our lives is the government going to take over? What willpower will be left if they keep doing more of this stuff?

Actually, I'm never convinced by these arguments from the professed defenders of our personal liberty.

Whenever I hear people banging on about "the nanny state" I wonder about their motives. Many of the critics are trying to keep government small so they're required to pay less tax.

These souls are often full of their own virtue. They attribute their comfortable circumstances entirely to their own efforts (forgetting the outside help they invariably had) and can't see why they should help others who aren't as disciplined as they are.

As for the libertarian think tanks leading the charge against the nanny state, you wonder how many of their undisclosed (but tax deductible) donations come from alcohol, tobacco and food companies anxious to resist any government measure limiting their freedom to profit from unhealthy products.

As the Grattan report – written by Hal Swerissen and Professor Stephen Duckett, a leading health economist – reminds us, there's little doubt that excessive overweight increases the risk of premature death, diabetes and cardiovascular disease.

Yet the incidence of obesity – a body mass index of more than 30 – is growing in the rich countries. The proportion of obese Australian adults is 28 per cent, up from less than 10 per cent in the 1980s. That's not counting the further 36 per cent who are overweight.

About 7 per cent of Australian children are obese, up from a negligible number in the '80s.

Although it may have plateaued among children, obesity continues to worsen among adults and seems likely to increase further.

Research suggests the main cause is overeating of processed food laced with sugar, fat and salt, which grows ever cheaper and available. The amount of exercise we get hasn't changed much over that time.

Health authorities and governments have been worried about an "obesity epidemic" for years, but nothing they've done so far seems to have worked.

This is probably because they've been tiptoeing around the powerful commercial food interests, focusing on individual responsibility, physical exercise and voluntary food labelling.

I agree it's time we did something more assertive and, though a tax on sugary drinks is far from a cure-all, it's a good place to start.

Lots of other countries are doing it, and have shown it works in discouraging consumption of sugary drinks and reducing obesity somewhat.

For us to impose it as a federal excise would be simple and administratively cheap. We already have excises intended to discourage us from smoking and overconsuming alcoholic beverages.

It would be paid by manufacturers and importers, then passed on to consumers, which would encourage people to move to bottled water, artificially sweetened drinks or even tap water.

A principle of libertarianism is that you should be allowed to do as you please as long as you're not harming others.

But as well as harming themselves, the obese also harm the rest of us. Evidence shows that, relative to others, the obese make more use of doctors, hospitals and pharmaceutical benefits.

All these impose higher costs on other taxpayers. Obese people are more likely to be on welfare benefits and less likely to be employed and paying income tax, which imposes further cost on other taxpayers.

Grattan estimates the cost to the rest of us is about $5 billion a year. The sugary drinks tax would recoup about $500 million a year of that.

Libertarianism assumes no one could possibly know our best interests better than ourselves. That's because we are unfailingly rational in the decisions we make. We have an iron will which stops us doing anything we later come to regret or being influenced by the behaviour of those around us.

In reality, all of us have a problem with self-control in at least one area of our lives and probably several.

And here's the bit nanny's critics never get: most of us are pleased when governments help us with our self-control problem by taking temptation out of our way.

Governments have used compulsory seat belts and random breath testing to reduce road deaths per head of population by more than 80 per cent. They've used sky high tobacco tax, bans on indoor smoking and other things to cut the rate of smoking by more than half.

It's high time they stood up to the processed food industry and did something effective about obesity.

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