OBSERVATIONS ON MACRO MANAGEMENT

Talk to Economic Society, Victorian branch, Wednesday, September 9, 2015

I want to draw on a few themes from my new book, Gittins: A life among budgets, bulldust and bastardry, particularly some observations about macro management, recessions and, what I consider to be my special subject, the politics of economics.

Don Stammer, the veteran business economist, says you need to have seen four recessions before you’re fully qualified. I thought the global financial crisis of 2008-09 would bring my fourth, but if you don’t count that---l count it as a potentially severe recession turned into a mild one by remarkably skilful management---I’ve seen three big ones. The recession of 1974-75 would by itself have caused the Whitlam government’s defeat had there not been more than enough other reasons. The severe recession of the early 1980s brought the Fraser government’s reign to an end after just seven years and the severe recession we didn’t have to have in the early 1990s---in the sense that all recessions happen by accident rather than design---finally did for the perpetrator of that bravado in 1996, although his execution was delayed three years by the political inexperience of a former economics professor, John Hewson.

I soon formed the view that recessions occurred roughly every seven years. I know from the three recessions that have occurred so far ‘on my watch’---each of them accurately branded ‘the worst recession since the Great Depression’---how terrible recessions are: the fear and pain they cause to small business people, workers who lose their jobs and young people who have the misfortune to be leaving school or university at the time. Whitlam’s recession saw the rate of unemployment shoot up from 2 per cent to 6 per cent, Fraser’s recession saw it peak at 10 per cent and Keating’s at 11 per cent. I know how thoroughly depressed people get for years on end, convinced things will never pick up again. I also know how bitter are the public’s recriminations against economists. Recessions may be a ‘good story’---in the sense they give people like me plenty to write about---but I hate them.

My notion that recessions occur about every seven years remains pretty true for all the developed economies bar Australia. Even if you count the mild recession of the GFC---which I do---it remains true we haven’t had a recession bad enough for ordinary people to notice for 24 years. There are two things to say about this.

First, in one sense only it’s a pity you have to be so old to know how terrible a severe recession is and hence to be hugely relieved, even grateful, we managed to avoid one in the aftermath of the GFC. About seven years later the North Atlantic economies are still embroiled in the Great Recession we escaped.

Second, that we’ve avoided severe recession for an unprecedented period is thanks more to good management than good luck. Even if you’re so ill-informed as to imagine our escape from the Great Recession is due purely to China and the resources boom, you still have to explain 17 years of uninterrupted growth since the recession of the early 90s, including our exemption from the world recession of the early noughties. We should have been brought low by the Asian crisis of 1997-98, but weren’t.

I decided very early in that 17-year period that the ultimate test of good economic management was to keep the recessions as far apart as possible, mainly because recessions put a lot of people out of work for long periods, and the longer you’re jobless the harder it gets for you to regain a berth. I could have decided the ultimate test was to keep the inevitable recessions as mild as possible. Either way, our economic managers pass with flying colours. I know Australians find it hard to believe Aussies could be world-class at anything but sport, but it happens to be true of our econocrats.

I know because I watched at close quarters as it happened and I know how they did it. It’s certainly true that our economic management was pretty bad for at least the first decade of my time as an observer. But between the late 80s and the early 90s the econocrats started getting their act together. Although most of the seeds were sown under the Hawke-Keating government, the Howard government was the first to enjoy the fruits. The Rudd-Gillard government also enjoyed them---as witness, its avoidance of the Great Recession---though it lacked the whit and internal cohesion to reap the harvest.

The econocrats did it by persuading their successive political masters to subject the conduct of day-to-day economic management to ‘frameworks’ of rules and targets intended to limit the scope for politically motivated short-termism. The obvious example is the decision---formalised by Peter Costello---to use an inflation target to guide decisions about changes in the official interest rate and to hand control over interest rates to an independent central bank.

The many acts of ‘micro-economic reform’---including floating the dollar, deregulating the banks and various other industries, phasing out protection against imports and shifting the locus of wage-fixing to the level of the individual enterprise---also helped. Micro reform failed in its stated objective of permanently lifting the rate at which the economy could grow, but it had an unexpected benefit: by intensifying the competition within industries it made the economy far less inflation-prone and unemployment-prone, thus greatly simplifying the macro-managers’ task in keeping the economy on an even keel.

What they do in Canberra

The theory of public choice holds, among other things, that politicians and bureaucrats always act in their own interest rather than the public’s interest, and that, whatever its original motivations, all government regulation of industry ends up being ‘captured’ by the industry and turned to the industry’s advantage in, say, reducing competition within the industry (to the incumbents’ advantage), increasing protection or in persuading the government to subsidise industry costs. The regulated have a huge incentive to get to the regulators so as to modify the regulation in ways the industry finds more congenial, or to advantage the existing players against new entrants or rival industries.

I don’t accept for a moment the accusation that all regulation of industry is subverted. But I do believe there’s more than a grain of truth to the accusation: there is considerable scope for regulatory capture. And I’ve long suspected that the way our bureaucracy is organised---where the department of agriculture looks after the farmers, the industry department looks after the manufacturers, the environment department looks after the greenies, the resources and energy department looks after the miners and the tourism department looks after the tourist industry---could have been purpose-built for regulatory capture.

In the various industries’ battle for their share of industry assistance, in the inter-departmental battle for influence and resources, each industry has its own special champion, those whose true role is supposed to be to keep the industry acting within the bounds of the wider public interest. Is the bureaucracy divided up this way just to gain the benefits of specialisation, or is each department’s real role to keep their particular industry happy and not making trouble for the elected government?

Of course, the two government agencies whose motivations and behaviour I’ve watched most closely are Treasury and the Reserve Bank. Being---like Prime Minister & Cabinet and the Finance department---‘co-ordinating departments’---Treasury and the Reserve have no particular industries they regard as ‘clients’. For instance, though the Reserve has daily dealings with the banks and the financial markets, I’ve never suspected its decisions about the level of interest rates were influenced by anything other than what it believed to be in the best interests of the wider economy over the medium term.

In other words, Treasury and the Reserve are on about macro management or ‘stabilisation policy’. But since they each wield different macro instruments, there is some specialisation between them. The question I ask is: what would they die in a ditch over? They care about lots of things, but what do they care about most?

In the Reserve’s case, the answer is inflation. Its attitude is, if we don’t accept ultimate responsibility for keeping inflation under control, who will? It also regards its instrument---monetary policy, or the manipulation of interest rates---as the best one to use to keep inflation in check. All this is implicit in its single target of keeping the rate of inflation between 2 and 3 per cent on average over the medium term. When it first adopted that solitary target 20 years ago, some took this to mean achieving low unemployment was not something it cared much about. Fortunately, our experience since then has dispelled such fears. The best way to think of its objective is ‘non-inflationary growth’. Even so, it does mean that, when forced to choose, fighting inflation will always come first.

So what does Treasury care most deeply about? What does it see as its ultimate responsibility, the responsibility others are less likely to care so much about? This took me longer to realise, but treasuries---state as much as federal---care most about the budget and getting it back to surplus just as soon as the state of the business cycle permits. As the recent troubles of governments in America and Europe attest, left to their own devices politicians are capable of running budget deficits year after year, in bad times and good, for decades until finally their lack of self control gets them into serious difficulties, invariably at the most inopportune times.

That our governments’ records have been so much more disciplined is testimony to our treasuries’ obsession with keeping budgets in balance ‘over the cycle’ and thereby avoiding the build-up of excessive levels of public debt. It’s testimony also to our treasuries’ greater success in persuading their political masters to curb their natural instinct to spend more than they raise in taxes.

Bearing in mind the wide discrepancy between the politicians’ willingness to increase taxes to cover their increased spending, much of Treasury’s effort goes into urging politicians to restrain their spending and into developing devices to help the co-ordinating, ‘purse-string’ ministers keep the other, ‘spending ministers’ in line. In this, Fraser’s attempt in the mid-1970s to punish Treasury by splitting a Finance department off from it---with Treasury responsible for revenue and Finance responsible for spending---had the unexpected effect of doubling Treasury’s influence at the cabinet table. It could have meant Treasury lost interest in the spending side of the budget, but it certainly hasn’t.

When Costello introduced the reforming Charter of Budget Honesty early in the Howard government’s term, he included---no doubt at Treasury’s suggestion---a requirement for Treasury to produce an ‘intergenerational report’ every five years to assess the fiscal sustainability of present government policies over the next 40 years. The first of these reports in 2002 found that (given a quite restrictive assumption about the growth in tax revenue) the present comfortable budget surpluses would soon give way to ever-growing budget deficits thanks to the ageing of the population and, more particularly, the public’s ever-growing demand for access to medical science’s ever-more-expensive advances in health care.

The following three reports have used the same assumptions to tell essentially the same story. From the first report it became clear to this (not unsympathetic) Treasury watcher that the report was being used by the treasurer as a kind of waddy to wave over the heads of the spending ministers. See the problems we face down the track? See how much worse it would be if I were to stop beating off your grandiose schemes? It was such a handy implement the state treasuries lost little time in producing their own intergenerational reports, each telling a story remarkably similar to federal Treasury’s.

But the state treasuries’ favourite disciplinary device is the state governments’ triple-A credit rating, ratings that emerged early in the Hawke-Keating government’s budgetary reforms when it ceased the practice of borrowing on the states’ behalf. No innovation could have been more effective in disciplining the states’ propensity to borrow, probably to the extent that it helps explain those governments’ inadequate spending on infrastructure.

State governments of both colours live in fear of the political censure that might follow a downgrading of their credit rating, not the modest increase in their borrowing costs it would also bring. And state treasurers exploit this fear indefatigably. When occasionally state governments do suffer a downgrading, they work untiringly to get their top rating restored.

I half agree with the academic economists who think too much attention is paid to credit ratings and that state governments could borrow for infrastructure investment a lot more heavily than they do without this creating an economic (as opposed to political) problem. I also suspect the rating agencies draw their lines in the sand more conservatively for governments than they do for businesses.

When you remember the big American rating agencies’ disgraceful contribution to the sub-prime debt debacle---where they sold paying customers triple-A ratings for the mortgage-backed securities they were issuing, only to have those securities ultimately revealed as ‘toxic assets’---you wonder why they give governments such a hard time. I finally decided they do it because they viewed the state treasuries as their clients, and know full well the treasuries want them to take a hard line.

But having conceded all that, I don’t criticise treasuries and their treasurers for the way they use credit ratings to beat back spending ministers’ insatiable demands for more spending on this worthy cause and that. What the academic critics forget is that their theories provide no clear dividing line between what level of borrowing is safe and what isn’t. In the real world of government, treasurers have to draw an unavoidably arbitrary line and then enforce it. If they use the bogeyman of credit ratings to keep their governments out of trouble, I’ve been loath to criticise.

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Depressed economists lose faith in capitalism

The nation's practicing economists are working themselves into a state over the future of the economy, convincing themselves the prospects for growth are dismal and the only answer is more "reform".

They're being rallied by former Treasury secretary Dr Martin Parkinson.

He told the National Reform Summit that Australia risked sacrificing as much as 5 percentage points of economic growth over the next 10 years, the equivalent of the production and income lost during a recession.

"Unless we grab this challenge by the horns and really get concrete about what are the priority issues, we are actually going to find ourselves sleepwalking into a real mess," he said.

There's a host of dubious assumptions hidden behind this stirring call to economic arms. For a start, how do we know we've got a problem? How do we know we're heading for a decade of slow growth unless the government acts?

We don't. We look at the below-trend growth in six of the past seven years and, as any economic illiterate would, simply extrapolate it for 10 years. But why stop at 10? Why not make it 40?

One of the shafts of enlightenment at the summit, we're told, came when a modeller from Victoria University challenged the inter-generational report's modelling that the productivity of labour would improve at an average annual rate of 1.4 per cent over the next 40 years. The rival modeller's modelling put it at less than 1 per cent.

Really? Talk about the biter bit. Rather than using their models to bamboozle the punters, economists are bamboozling themselves, mistaking an "exogenous" variable for an "endogenous" one.

Putting that in English, both the 1.4 per cent and the 1 per cent are merely assumptions, not a finding of the models. No economist knows what will happen to productivity over the next two years, let alone the next 40. And no model can tell them.

All the economists are doing is what any mug punter would do: relying on gut feel rather than science. You may be optimistic about the future, but I'm pessimistic.

They're making the economic illiterate's assumption that our recent weak growth is structural rather than cyclical. Sure, falling commodity prices are reducing our real income, but one day they'll stop falling.

Sure, we're making heavy weather of the transition from the resources boom, but one day it will have been made. Simple statistical theory should be telling economists that a protracted period of below-average growth is most likely to be followed by a period of above-average growth.

The next weird thing about the economists' bout of depression is their assumption that the economy will go nowhere without government intervention. It's as though they've lost their faith in capitalism.

The economy isn't a living organism whose growth and striving is driven by consumers' self-interest and producers' profit-seeking; it's more like a marionette whose animation depends on the Public Puppeteer continually jerking its strings.

Economic growth, it seems, is exogenous not endogenous. Really? What textbook did you read that in?

When you convince yourself, as many economists have, that the only way we'll see faster growth and further productivity improvement is for governments to engage in extensive reform, you've convinced yourself our economy is deeply dysfunctional.

Hugely inflexible and uncompetitive, highly protected, rife with cartels and lazy government-owned monopolies.

You're saying all the (unrepeatable) reform of the 1980s and '90s – floating the dollar, deregulating the financial system and a dozen industries, removing import protection, decentralising wage-fixing and privatising or corporatising public utilities – delivered a once-only productivity improvement but no lasting gain in efficiency, flexibility or dynamism.

There's nothing about those reforms that will help the economy grow in the future, you imply. Somehow in the intervening decade or so all those reforms have disappeared under a jungle of inefficiency; the jungle that's preventing us from ever returning to our former average growth rate.

So now you're threatening to slash your wrists unless the government trawls through all the second-string reforms not yet made and gets on with them.

Naturally, your best advice on how we can get productivity improving faster relies on the things economists think matter most: prices (including tax rates and the wage-fixing system) and intensifying competition (much of which would appal the Business Council and other industry lobbies).

And what do we get if we follow your advice? Another fleeting productivity improvement or something of continuing benefit?

Sorry, guys, but the propositions you're advancing are more like a high-pressure sales job than a rational analysis of our future opportunities and threats. Why don't you take a break and cheer up?

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Contrary to reports, economy battles on

Joe Hockey is right. The economic news is hardly wonderful, but the media's attempt this week to convince us the economy was perilously close to recession was sensationalist nonsense.

What set them off was news from the Australian Bureau of Statistics' national accounts that real gross domestic product grew by just 0.2 per cent in the June quarter. What they forgot to mention was that in the previous quarter it had grown by 0.9 per cent.

As Hockey says, the figures "bounce from quarter to quarter". But why let that small fact get in the way of a good scare story?

The less excitable Dr Chris Caton, of BT Investment Management, put it another way: "The weak growth for the June quarter was in part payback for the strong growth in the March quarter."

Just so. We were told, for example, that spending on home building fell by 1.1 per cent in the latest quarter, but not reminded that the previous quarter it had grown by a remarkable 5.6 per cent. There is no reason to believe the housing construction boom has ended.

We were told that the volume of exports fell by 3.3 per cent in the latest quarter, but not reminded that in the previous quarter it had grown by 3.7 per cent. Turns out the weather was unusually favourable around bulk-commodity ports in the first quarter, but unusually bad in the second.

We weren't told about these one-off negatives for growth in the June quarter, but much was made of a one-off positive: a sudden surge in defence spending, we were told, fully accounted for the quarter's 0.2 per cent growth.

(Actually, it was worse than that. Whereas total public sector spending made no contribution to overall growth in the March quarter, it contributed 0.6 percentage points in the June quarter.)

All this is why searchers after truth rather than headlines don't take quarterly changes in GDP too literally. Combine the two quarters and you get average quarterly growth of 0.55 per cent, or annualised growth of 2.2 per cent - which is probably closer to the truth.

It also fits better with a fact we were told only in passing, that the economy grew by 2 per cent over the year to June and by 2.4 per cent on average over the financial year, meaning Treasury's forecast of 2½ per cent was near enough to right - a point Hockey kept making and the media kept ignoring.

Examine the figures for the year to June and you don't find much evidence of an economy likely to collapse in a heap. Consumer spending grew by 2.5 per cent, home building by 10.4 per cent, public sector spending by 3.3 per cent.

Export volumes grew by 4.5 per cent, while import volumes fell by 0.7 per cent. In fact, apart from a small fall in the level of inventories, the only major negative contribution to growth came from business investment spending, which fell by 4.1 per cent.

That fall comes from the end of the mining construction boom, of course. It's a reminder of the truth of our position - that our transition from mining-led growth to more normal sources of growth has been far from smooth and isn't achieved yet - a truth too prosaic for the headline chasers. Growth in the low 2s is clearly well below average.

But if you dig a bit deeper you do find signs that the transition is proceeding, with help from record low interest rates and an ever-lower dollar.

For a start, there is evidence of recovery in non-mining investment. According to rough figuring by Kieran Davies, of Barclays bank, it's up by 4 per cent over the year to June, led by investment in the services sector.

Exports of services - including tourism and education - are also growing. Though little changed in the June quarter, their volume was up 7 per cent over the year, Davies says.

"With imports of services down 8 per cent over the past year as the falling exchange rate has made it more expensive to take an overseas holiday, trade in services [exports minus imports] added 0.1 percentage points to GDP in the June quarter and 0.6 percentage points over the past year."

Much has been made of the 1.2 per cent fall in "real net national disposable income per person", rightly described as the best measure of material living standards the national accounts provide. It's fallen for five quarters in a row.

Why? Because of the deterioration in our terms of trade - the prices we receive for our exports relative to the prices we pay for our imports - as coal and iron ore prices have fallen.

But it's important to see this in context. Why do so many people care so much about economic growth? I (and Joe and his boss) think it's mainly because they want to see more jobs created.

If so, real GDP - the quantity of goods and services workers are employed to produce - is a more relevant indicator than the various measures of "real income".

And the growth in GDP we've had has been sufficient to create 240,000 jobs over the year to July (including 68,000 during the supposedly knackered June quarter) and to stabilise the unemployment rate at just over 6 per cent.

It's true that the size of our real income has an effect on our spending on goods and services, and the demand for goods and services affects employers' demand for workers.

But much of the loss of income caused by lower coal and iron ore prices is borne by the mining companies (which are about 80 per cent foreign owned) and by state and federal governments (which collect lower mining royalties and company tax), rather than by the rest of us.

Times aren't easy, but we're not in bundle-dropping territory.

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The game pollies play rather than governing

It came to me while I was lying awake the other night: the business, union and community worthies at last week's National Reform Summit thought the way to make progress was to hammer out a compromise proposal most people could agree to. You hand it to the government, the opposition agrees, they whack it through parliament and problem solved.

But that's not the game Tony Abbott is playing.

He doesn't want agreement, he wants disagreement, but with the government on the majority side and its opponents on the minority side. That way, you get re-elected and maybe, as a bonus, there's some benefit to the country.

Pretty bad? Here's the worst part of my early-hours revelation: the other side's no better.

This is the way both sides have been playing the political game for years. It's just more obvious now because Abbott doesn't play it with as much finesse as his predecessors.

In Canberra, the game is known as "wedging", but is better described as "wedge and block". Whoever's in government thinks of issues acceptable to their side – and popular with voters – but inconsistent with the other side's values and thus likely to divide it. Ideally, the others oppose you and so get themselves offside with most voters.

Failing that, the pragmatists on the other side – who see perfectly what you're up to – reluctantly go along with you, but a more principled minority don't, so you've sown dissent among your opponents. Always a bad look to the electorate.

If the practitioners of expedience get their way without noticeable demur from the keepers of party principle, the wedge has been successfully blocked and you have to go away and think up another one.

How do you come up with a good wedge issue? You consult those polls that regularly ask voters which party is better at handling particular issues. Study these results and you find voters have highly stereotypical views about the parties' strengths and weaknesses.

The Liberals are better at what you'd expect a penny-pinching bosses' party to be better at: managing the economy, fighting inflation, keeping taxes and interest rates low and controlling the budget. And, of course, keeping the country safe from threats to our security.

Labor, on the other hand, is better at what you'd expect a big-spending workers' party to be better at: unemployment, social security, health, education, the environment and industrial relations.

In the months leading up to an election, each side manoeuvres to establish as key election issues problems the voters regard them as better at dealing with. They try to neutralise – block – those issues the other side is pushing that would leave them at a disadvantage.

The sainted Julia Gillard wasn't too saintly to use her two most popular (and expensive) measures to try to wedge Abbott at the 2013 election.

She proposed a 0.5 percentage point increase in the Medicare levy to help pay for the national disability insurance scheme, hoping Abbott would object and so could be accused of opposing greater assistance to the disabled.

She delayed the Gonski reforms to school finding, hoping Abbott would defend private schools and she could make it a key election issue.

Abbott blocked both wedges. He quietly agreed to the tax increase which, becoming uncontentious, was never mentioned again. On the Gonski reforms he belatedly professed to be on a "unity ticket" with Labor. But the delay meant many Liberal state governments declined to sign up to the scheme so close to an election.

Abbott's efforts to wedge Labor have come thick and fast in recent days. He asked President Obama to ask us to join in the US bombing of Syria because he was hoping Labor would object to such an ill-judged move. It didn't.

In another effort to increase public concerns about national security, he propose stripping certain Australians of their citizenship, hoping Labor would object and so allow him to accuse it of being "soft on terrorists". It didn't.

Abbott is anxious to portray his government as big on "jobs and growth". He cooked up a story about greenies using the law to block a new coal mine in Queensland and proposed amending the federal environment protection act to counter "green sabotage", hoping Labor would object and he could accuse it of putting the environment ahead of jobs.

As became clear at last week's reform summit, there's now widespread agreement that superannuation tax concessions to high-income earners are too generous and need to be cut back, with big savings to the budget.

Earlier this year, Joe Hockey had Treasury working on super changes when Labor announced it would take such a policy to the election. Abbott immediately embarrassed Hockey by insisting the government would countenance no changes to super or any other tax concessions.

Labor may stand for higher taxes, he told us, but the Libs stood for lower taxes. He made it clear last week that, come hell or high water, the government would go into next year's election promising tax cuts.

Great wedge. One small problem: all Labor has to do to block it is promise to match it – just as it did when John Howard tried the same thing at the 2007 election.

Bad policy, but what of it?

If you wonder why our politicians don't seem interested in good government, their addiction to playing the wedge-and-block game explains a lot.

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How high-paid men have hijacked tax reform

It's difficult to get a man to understand something when his after-tax salary depends on him not understanding it, to misquote Upton Sinclair.

This may explain why there's a glaring weakness in the thinking of business people, economists and politicians who see countering bracket creep and cutting the top tax rate as the key "reforms" needed to "reward hard work" and increase participation in the labour force.

Joe Hockey's repeated claim that our tax system remains much the same as it was in the 1950s is silly but, as Professor Patricia Apps, of the University of Sydney, argues in a recent paper, it's true in one important respect.

Then, our system of levying income tax on the individual, rather than the joint income of couples, fitted well with our (very Australian) system of tightly means-testing welfare benefits on the basis of family income.

Why? Because, in those days, few women continued in paid employment once they were married and, certainly, once the kids started arriving.

What's changed is a decline in the fertility rate from about 3.5 children per female to 1.9, a rise in young women's academic attainment to levels exceeding young men's, and a desire by most young mothers to return to paid employment.

Get it? Without intending to we've moved away from having the individual as the unit of taxation – a choice that scores well on both efficiency and equity – to a "quasi-joint" system of taxing families.

In consequence, when one partner – usually the father – has a full-time job, and the child-caring partner thinks about returning to paid employment, her degree of participation is discouraged not just by marginal tax rates that have risen somewhat thanks to bracket creep but, far more significantly, by the rate at which the family tax benefit is withdrawn as the wife's income is added to the husband's.

This means women deciding whether to work, and how long to work, face "effective" marginal rates of taxation far higher than the top rate of 47 per cent faced by all the executives Hockey fears will become tax exiles at any moment.

Apps demonstrates from 2010 survey figures that, before a couple's kids arrive, women, on average, work almost as many hours as men. Women's hours fall markedly when the couple has at least one child of preschool age.

That's to be expected. But Apps shows that when the average couple reaches the stage where all dependent children are of school age, mothers' hours recover to only a little more than half those of the husbands'.

The gap is only a little narrower when couples reach the stage where both parents are still of working age but have no dependent children at home.

In other words, decisions made to reduce participation in the labour force in the preschool years tend to persist even as the kids grow up.

Why could this be? Surely not because "secondary earners" (aka mothers) face effective marginal tax rates in the high double figures. If so, countering bracket creep and cutting the top rate aren't likely make much difference.

Apps' analysis goes a long way towards explaining why rates of female participation in Australia are significantly lower than in comparable countries – even New Zealand – particularly when you remember our unusually high rates of part-time female participation.

If so, she also goes a long way towards identifying the area where tax reform is likely to be most effective in encouraging work effort and participation.

Apps uses Australian data to support an empirical truth long understood by tax economists, but long forgotten by other economists and never believed by high-paid businessmen (see opening quote): the price "elasticity" (sensitivity) of labour supply is not at all high for "primary" income earners (men with full-time jobs). Other studies show much higher elasticity for "secondary" earners.

This is common sense: full-time jobs tend to come in set lumps of 38 hours or so a week, whereas mothers have far more discretion over how many hours a week they want to work. It's mainly the shift from part-time to full-time that our unintended "quasi-joint" unit of taxation is stuffing up.

There's nothing new about high effective marginal tax rates. So why do economists and their high-paid male masters keep forgetting it?

Because if they can con the pollies into cutting the top tax rate rather than fixing the means-testing of family benefits, they pay a lot less tax whether or not the "reform" encourages greater work effort in general and whether or not they personally choose to work harder or take Wednesday afternoons off for golf.

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Try a little compromise to fix the budget

It was easy to miss, but a proposal with much practical potential arose from this week's meeting of the great and good at the National Reform Summit. It was an idea that could break the budget impasse.

Australia is seen to have so many economic problems at present that the participants at the summit from business, union and community peak bodies got to four of them before later remembering one I would have had at the top of my list. As someone thought to write into the final statement, "unconstrained climate change would have serious environmental, economic and social impacts on Australia".

Oh yes, that probably could be a bother, couldn't it? Glad we remembered to pop it in.

The problems that got more considered attention were: lifting productivity growth and workforce participation, tax reform, sustainable retirement incomes policy and, of course, "fiscal policy for a growing economy".

On fiscal policy – the budget – the participants began by acknowledging that "governments have a key role to play in providing or funding public services, a social security safety net and economic and social infrastructure essential for economic growth".

Here's an important point of agreement: "All expenditure programs, including direct expenditures and tax concessions, should be subject to rigorous evaluation to ensure efficiency and effectiveness over time."

To date, the Abbott government has insisted on excluding tax concessions.

Government income-support payments should be appropriately targeted to those who most need them, we're told, but also this: "Gaps in the basic social safety net should be closed, such as improving the adequacy of income support for unemployed people and affordable housing for people on the lowest incomes, and services to people with a disability."

Plus this: "People on low incomes or who are otherwise vulnerable should be protected from the impacts of fiscal reform."

See how much more reasonable business people become when you bring them face-to-face with the unions and welfare organisations?

The participants' list of things governments should do says they should "rigorously monitor the effectiveness of all expenditure programs, including tax and direct concessions, and make findings public".

You might think that, no matter how bad our budgetary system is, it couldn't be as bad as the Americans'. That's probably true, but in one respect they beat us hollow: Congress is diligent in monitoring the effectiveness of spending programs and making the results public.

Our taxpayers would save a lot of money if only ministers and their department heads were more willing to check how well their programs were achieving their stated objectives and then let us in on the secret.

So far, the summiteers' statement of principles is all very sensible, but what about Tony Abbott's "budget emergency" – do we have one or don't we?

We don't, but we will if we're not careful.

"While we currently have low public debt levels by international standards, expenditure in a number of key areas is rising rapidly, owing largely to population ageing in areas like pensions and age care, and rising health costs for all," the final statement says.

"Weaknesses are emerging in our public revenue base. These have been papered over temporarily by income tax bracket creep at the Commonwealth level and a surge in housing stamp-duty revenues in some states, but neither is a sustainable source of public revenue . . .

"If current policy settings persist, federal and state governments are likely to post substantial deficits for many years to come."

Just so. Which brings us to our present impasse on the budget. In 2014 the government allowed us to see the harsh recommendations of its commission of audit only a week or so before its first budget, which implemented a version of them.

The public reacted in amazed horror, partly because they involved breaking a lot of election promises, but mainly because they were seen as unfair to low and middle income earners. Not surprisingly, the Senate declined to pass many of the worst measures.

Abbott's standing in the opinion polls has never recovered from the unpopularity of that first budget, even though he used his second to backtrack on many of his stalled measures and to buy a bit of approval from couples needing childcare and from small business.

Joe Hockey used some dodgy assumptions to claim the budget was still on track to return to surplus in 2020, but few at the summit believed him. With 2016's a pre-election budget, it's hard to foresee a renewed effort to get things heading in the right direction.

But this is where the summiteers' good idea comes in. Partly in response to comments at the summit by Dr Martin Parkinson, the former Treasury secretary, Peter Harris, of the Productivity Commission, and Professor Peter Whiteford, of the Australian National University, the peak bodies got together and came up with a plan to return the budget to "structural balance" within 10 years.

The idea is to separate significant structural reform of the budget from the annual budgeting process conducted by Treasury and Finance. A new assemblage of peak bodies would be given two years to develop a plan to get the budget back to balance over the following eight years.

On the spending side, the new outfit would focus on the biggest and fastest-growing programs, such as health, where inefficiencies were identified and removed while protecting their adequacy and fairness. (Any medico will tell you there's plenty of wasteful spending in health.)

On the revenue side, reforms would focus on tax concessions that were no longer "fit for purpose".

Such a process would be more public, would produce more "buy in" by key interest groups, would impose greater pressure on vested interests to make concessions for the greater good and, if done well, would do more to help voters see the need for reform and the measures proposed.

Well worth a try.

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Talk to VCTA Teachers Day, Melbourne,

Talk to VCTA Teachers Day, Melbourne, Friday, August 28, 2015

Since it’s an important part of the course, I thought it might be useful if I give you an update on recent facts, figures and trends in the key indicators of what’s happening in the labour market, to help you keep up-to-date. I’ll be relying heavily on an article by professors Roger Wilkins and Mark Wooden, both of the Melbourne Institute, Two Decades of Change: The Australian Labour Market, 1993 - 2013, published in the December 2014 issue of the Australian Economic Review. We’ll start on the supply side, with participation, then move to the demand side and on to indicators showing the outcome of the interaction of demand and supply, such as unemployment.

Labour force participation

If you look at the overall participation rate since 1993, after the recovery from severe recession of the early 90s had begun, you see a reasonably strong rate of increase until the global financial crisis in late 2008. But this is misleading. All the increase came from rising female participation. Among men, the long-term downward trend continued, though at a slower rate of decline. However, in the five years before the GFC male participation rose a little. Since the GFC it has fallen by 2 pc points.

Note that some part of the fall in the male and overall part rates since the GFC is explained by demographic factors - that is, the retirement of the baby-boomer bulge. To get an indication of the size of this effect, Wilkins and Wooden calculated that if the age structure of the population - that is, the proportions in each age group - in 2013 was the same as it had been in 1993, the overall part rate would have been 2.2 percentage points higher. That is, population ageing seems to have reduced the part rate by a least 2 percentage points so far. We need to remember this when we look at the lower part rate in recent times - demographic as well as cyclical factors are at work.

Looking at the part rates for men, over the 20 years to 2013 the overall rate has fallen form 73.5 pc to 71.4 pc. The fall has been greatest for men aged 15 to 24, mainly because more are staying longer in the education system before starting work. Part rates for prime-age men - 25 to 54 years old - have fallen to lesser extents. But the part rate for men aged 55 to 59 has risen from its low in 1993 by 9 pc points to 80.8 pc in 2013. For those aged 60 to 64, it’s risen from a low in 1998 by 17 pc points to 62.5 pc. And for those aged 65 and above, the part rate has more than doubled over the 20 years to almost 17 pc.

The trend to early retirement - voluntary and involuntary - that started in the 70s and ran through to the early 90s, has really turned around since then and more men are waiting longer before retiring. A significant minority are continuing to work beyond age-pension age of 65, no doubt many of them part-time. I think this would be happening because many felt they hadn’t yet saved enough to live comfortably in retirement on an income above the pension, because more of them would be in better health and expecting to live longer than earlier generations were and more of them would have worked in less physically demanding jobs.

Turning to women, their overall part rate has risen continuously over the past 20 years, by almost 7 pc points to 58.6 pc. That’s true of all age ranges except for a very recent decline among those aged 20 to 24 - no doubt because more young women are going on to uni. By far the biggest pc point increases have been for those aged 55 to 59 (up more than 28 pc points to 65 pc) and 60 to 64 (up 30 pc points to 45 pc). Even the part rate for women 65 and over has risen by almost 6 pc points to 8 pc. The reasons for great proportions of older women remaining in the labour force longer include those I listed for men, plus the raising of women’s age-pension age from 60 to 65, and the fact that, with so many women now more highly educated and hence better paid, more of them, having returned to the workforce after having children, would want to stay there for the duration.

 Looking to the future, there is plenty of scope for part rates among older people to continue rising. So, is the retirement of the baby-boomer bulge lowering the overall part rate or isn’t it? As you’ve probably realised, these days a fully-furnished economics teacher needs to know a bit about demography. Here we are balancing two separate effects. The fact that some older workers are choosing to retire later doesn’t alter the fact that population ageing is causing a lower proportion of the population to be of prime working age and a higher proportion to be of later age. This change in proportions guarantees that overall part rates will be lower. The decision of some older workers not to retire as early as they might have reduces the extent of the ageing-caused fall in the overall part rate, but is unlikely ever to eliminate it. This is because, although some choose to keep working, most do not. It’s unlikely we’d ever get to the stage where part rates among the over-60s were just as high as for prime-age workers.

Immigration

Roughly half the increased supply of labour comes from ‘natural increase’ (young people joining the labour force exceeding old people leaving it) and half from ‘net migration’. Immigration has been making a significant addition to the labour force since the end of World War II, and today accounts for more than a fifth of it. The main change since the turn of the century is that a smaller proportion comes on permanent visa and a much higher proportion on various classes of temporary visas.

In March 2014 there were 880,000 people on temporary visas with work rights, including 200,000 on temporary skilled (457) visas and 370,000 on student visas (not including many young people on working holiday visas). If all these people were actually participating in the labour force they would account for 7 pc of it. In addition there were 640,000 people on visas for New Zealanders. Since the early 2000s the annual intake of people on 457 visas has risen from 40,000 to 130,000 in 2012-13. These figures compare with an annual intake of skilled permanent migrants of about 130,000. In practice, many permanent visas are issued to people on temporary visa who decide to stay.

This shift to temporary migration has made the labour force more flexible in its ability to respond quickly to changes in demand for skilled workers without producing excessive rises in skilled wages. However, it has probably also reduced the incentive for employers to invest in training local workers. Note, too, that levels of net migration tend to vary with the strength of our business cycle.

Educational attainment

Now let’s move from the size of the supply of labour to its quality. The past two decades have seen continued growth in the proportion of the labour force with post-school qualifications. The proportion with a university degree has more than doubled from 12 pc to 28 pc. The proportion with trade qualifications has risen from 16 pc to more than 20 pc.

Employment

The best indicator of labour demand is the employment-to-population ratio - the ratio of total employment to the total population of working age (15 and over). Because the base is the total population rather than the labour force it will always be lower than the part rate. This employment ratio is getting more attention because it is now being included in the monthly labour force survey.

The employment ratio tends to vary directly with the business cycle. In mid-1993 following the recession of the early 90s it got to a low of 55.4 pc, but then slowly rose to a peak of 62.8 pc in late 2008 before the GFC, falling to 61.7 pc about a year later. It recovered temporally until late 2011 when it began falling again, reaching a low of 60.6 pc at the end of 2014. By July, however, it had recovered to 60.9 pc. The employment rate is reduced by population ageing, of course.

Unemployment and labour underutilisation

Unemployment represents the mismatch between labour supply and labour demand, the extent to which the labour market has failed to clear. The official unemployment rate is derived from the monthly labour force sample survey of more than 26,000 households. The official rate reached peaks of 10.4 pc in the recession of the early 80s and 11 pc in the recession of the early 90s. By 1993 it had fallen little, but over the following 15 years to early 2008, before the GFC, it got down to 4.1 pc. By mid-2009 it had risen to a peak of 5.8 pc, but recovered to a low of 4.9 pc in early 2011. It slowly worsened thereafter, but by mid-2015, however, it seemed to have stabilised at about 6 pc.

The official unemployment rate has not been tampered with by politicians, as many people believe, nor has the Bureau of Statistics changed its definition of unemployment for many decades. It is true that this definition is very narrow, in that anyone working as little as one hour a week is classed as employed. This narrow definition clearly understates the full extent of unemployment.

This explains why, some years ago, the bureau began publishing the under-employment rate, representing the proportion of the labour force that is employed but working fewer hours than desired. The underemployment rate did not slowly decline over the 90s and the noughties as the unemployment rate did, but stayed fairly steady over that period and has edged up a little during the 2010s. This means that, by the turn of the century, it went from being below the unemployment rate to being above it. Figures for the underemployment rate are published quarterly, for the middle month of the quarter. In May 2015 it stood at 8.4 pc, compared with the unemployment rate of 6.2 pc. Adding the two together gives a “labour force underutilisation rate” of 14.6 pc.

Note, however, that the underutilisation rate tends to go too far the other way by overstating the extent of the problem. This is because it counts the number of underemployed employees (and unemployed workers) without taking account of each person’s degree of underutilisation, whether they were a part-time worker wanting only an extra hour or two of work or, at the other extreme, were an unemployed worker seeking a full-time job. The bureau calculates a “volume-based” measure of underutilisation for August each year. In August 2014 it was 8 pc, compared with the “headcount-based” measure of 14.4 pc.

Wilkins and Wooden discuss another dimension of underutilisation: the extent that workers were not making use of all their skills and qualifications in their paid employment. Using data from the annual HILDA survey rather than the bureau’s surveys, another group of academics has estimated that, during the period from 2001 to 2006, 14 pc of workers were severely over-skilled (ie they made very little use of their skills and abilities in their current job), while a further 30 pc were moderately over-skilled. Wilkins and Wooden detected no trend in this measure over the past decade.

Youth unemployment

The rate of unemployment is always significantly higher among the young than among older workers. This partly because the young are more inclined to leave one job in the hope of trying another, because their lack of experience may make them less attractive to employers and because they suffer the brunt when the economy turns down. More recent employees may be the first to be laid off. And policies of reducing staff sizes by natural attrition usually involve suspending the annual entry-level intake at the expense of youngsters leaving the education system. The longer they remain unemployed, the harder it becomes for them to find a job.

In July 2015, the overall rate of unemployment was 6.3 pc, whereas the rate for 20 to 24-year-olds was 10 pc and for 15 to 19-year-olds was 19.3 pc. That is pretty much the highest it’s been since November 1997. Many of these teenagers would have quit school early, often with inadequate literacy and numeracy. Six years after overall unemployment reached its peak following the GFC, the overall rate rose by 0.3 pc points, whereas the rate for 20 to 24-year-olds rose by 1.4 points and for 15 to 19-year-olds rose by 2.5 points. This means one in five unemployed Australians is a teenager.

Note, however, that a teenage unemployment rate of almost 20 pc doesn’t mean that one teenager in five is unemployed. This is because it’s 20 pc of the teenage labour force (not the teenage population) and many teenagers are not in the labour force because they are in full-time education and not working or actively seeking work. It’s nearer one teenager in 10 that is unemployed.

Non-accelerating-inflation rate of unemployment

The NAIRU - or natural rate of unemployment - is the lowest rate to which unemployment can fall without shortages of labour leading to rising wage and price inflation. It’s regarded as the modern level of full capacity or full employment, or the lowest sustainable rate of unemployment.

The NAIRU changes over time with changes in labour market institutions and no one can say with certainty what its level is. Different economists do different calculations and reach a range of answers. However, the consensus among the econocrats is that the NAIRU is “about 5 pc”. But the only sure way to determine where it actually is, is to see how low it can get when the economy has been growing strongly before signs of wage pressure emerge. Considering the extent to which wages growth has slowed - to 2.3 pc a year - at a time when the official unemployment rate has risen only to a bit above 6 pc, my guess is the NAIRU may be nearer 4 pc than 5, maybe even less than 4.

The hardest question I have to answer from the public is how full employment could possibly be as sky-high as 5 pc. Wasn’t it less than 2 pc in the post-war years? Yes it was. But the structure of the economy has changed hugely since then, and most of the increase in the rate of full employment would be an increase in structural unemployment. Many people don’t realise that the unemployed tend to be unskilled and unsuited to fill whatever job vacancies are available. Figures taken from the HILDA survey by the Brotherhood of St Laurence show that in 2008, when the economy was booming just before the GFC and the unemployment rate got to a low of 4.1 pc, 45 pc of the unemployed were early school-leavers and a further 20 pc had gone only to year 12. That left 16 pc with trade qualifications and less than 20 pc had degrees. The problem is there aren’t as many jobs available for unskilled and low-skilled workers in the digital age as there were in the 1960s.

Overwork

Apart from the rise in part-time employment, the 1980s and 90s saw a marked increase in the proportion of men working very long hours. In the noughties, however, the proportion of male full-timers working 50 hours or more a week fell from 31 pc in 2003 to 27 pc in 2013. This has occurred despite an increase in the proportion of men working as managers and professionals. Among women, the proportion of hours worked changed little over the period.

Job insecurity and “precarious employment”

It’s widely believed that there is an ever-growing incidence of “precarious employment” - people in casual jobs, or on short-term contracts, or working for labour hire companies or temping agencies, or being cast adrift by their employer without benefits as supposedly self-employed. I know it’s widely believed among teachers that, these days, no one stays in the same job - even the same occupation - for long. More and more people are being made redundant. A young person leaving education can expect to have many different jobs before finally they retire at 70.

These perceptions may be widely held, but there is little evidence to support them. It is true we have a lot of part-time and casual employment in Australia - more than in most other rich countries - much of it done by mothers with young families and students who aren’t wanting a full-time job. And, these days, by people in semi-retirement. It’s also true that the number of part-time and casual jobs grew rapidly for several decades. It’s still growing, but much more slowly. According to Wilkins and Wooden, over the 10 years to 2013 the proportion of men working part-time has increased by 2 pc points to just under 18 pc, while the portion of women has been steady at almost 48 pc.

While most part-timers are also casuals, the two groups don’t overlap completely. The Bureau of Statistics defines casual employment as not receiving paid annual leave and sick leave. Its figures show that, for men, the proportion of casuals has been relatively steady since the late 1990s, fluctuating around 20 pc. Among women the share has fallen from about 31 pc to less than 27 pc.

The annual HILDA survey shows that more than two-thirds of workers were in permanent or ongoing employment in 2012, an increase of 1.5 pc points since 2001, when the survey began. HILDA suggests the share of labour-hire and temporary-employment agency jobs has fallen over that time from 3.7 pc to 2.7 pc. (It would be much higher than that in particular industries, of course.)

Nor can Wilkins and Wooden find any evidence that there’s been a shift away from employment to greater use of self-employment. Indeed, the bureau’s figures show the proportion of self-employed in the workforce has being steadily declining over the past 20 years, from 14 pc to 10 pc in 2013.

Then there’s the widespread perception that these days people are always losing their jobs and having to move on. When employers announce mass layoffs it invariably gets much attention from the media. When there’s nothing to announce it gets no attention. The bureau’s figures for average job duration and rates of job mobility show little sign that jobs have become less stable, according to Wilkins and Wooden. In February 2013, just 18 pc of the employed had been in their job for less than a year, down from 22 pc in 1994. In the latest figures, just over one worker in four had been in their job for at least 10 years, up from 23.6 pc in 1994.

How long people stay in the same jobs is determined by dismissals and quits. If jobs are becoming less secure you’d expect dismissals to be up and voluntary departures down. Both of these vary with the ups and downs of the business cycle but, even so, they’ve tended to decline. In February 2013, less than 3 pc of all the people who’d had a job in the previous 12 months had been retrenched. The proportion losing their jobs for any reason was 6 pc. About 10 pc of people had quit their jobs.

Earnings

The 20 years to 2013 have seen strong growth in real wages as the economy’s upswing continued. The real average weekly earnings of full-time employees grew by 38 pc for men and 37 pc for women. But the period saw no convergence between men and women in average weekly earnings, with the gap being 25 pc and 1993 and 26 pc in 2013. Other figures show the real hourly earnings of part-time workers increasing between 1995 and 2012 by 33 pc for men and 24 pc for women.

By contrast, between 1998 and 2013 the federal adult minimum wage rose by just 8 pc in real terms (compared with a 25 pc increase in real average weekly earnings over the period). Historically, the ratio of minimum wages to average wages has been a lot higher in Australia than in other developed countries, but this suggests it has been dropping back to the pack.

It also suggests that wage gains have not been uniform across the earnings distribution. Wilkins and Wooden use the bureau’s income survey to show that, comparing real earnings in 2012 with those in 1995, the percentage increase in the earnings of full-time employees is highest at the top of the distribution and lowest at the bottom. At the 10th percentile the increase was 15 pc, whereas at the 90th percentile it was almost 50 pc. So earnings inequality increased over the two decades. The Gini coefficient rose significantly from 0.26 to 0.29 for men (ie by 12pc) and from 0.21 to 0.25 (ie by 19 pc) for women. So, unlike in the United States, real wages at the bottom have grown to a fair extent, but higher wages have grown by a lot more, with middle wages growth somewhere in between.

The authors say the causes of this increased inequality in earnings aren’t well understood. In the US, increased international trade and skill-biased technological change are regarded as the most likely causes, with more emphasis on skill-biased change (ie computerisation that tends to reduce demand for less-skilled workers and increase it for high-skilled workers) than on trade (ie manufacturing and less-skilled service jobs shifting to developed countries). Both causes may have been at work in Australia. Ian Watson has argued that the increase in earnings inequality is the result of “neo-liberal” policies, such as deregulation, contracting out, reduced protection and privatisation. Another likely candidate is the decentralisation of wage-fixing with the move to enterprise bargaining.

Note that earnings inequality is not the same as income inequality. This is because, wages are not the only form of income, because the unit of analysis for earnings is the individual worker, whereas for income it’s usually the household (which may contain one or two earners, each on very different wage levels), and because measures of income inequality usually take account of the income redistribution brought about by income tax and cash transfers (including to non-workers, such as the aged, the unemployed and many sole parents). For these reasons, income inequality hasn’t increased to nearly the same extent that earnings inequality has.

Conclusion

The first of the big changes in the labour market we’ve seen over the past 10 or 20 years is the effect of the retirement of the baby-boomer bulge in significantly lowering the participation rate, which has been only partly offset by the reversal of the trend to early retirement, including more people continuing to work beyond the age-pension age of 65. Immigration continues to account for about half the annual growth in the labour market. The main changes have been the increased emphasis on skilled migration and on the issue of temporary rather than permanent visas, which has probably discouraged employers from doing as much training of local young people. Levels of educational attainment continue to rise. The narrowness of the standard definition of unemployment has led to publication of broader measures, which reveal a much greater underutilisation problem. The NAIRU is said to be about 5 pc, reflecting higher structural unemployment. The wide belief that jobs are getting more insecure and lasting fewer years is contradicted by the evidence. Earnings have become much more unequal, but other changes have limited the effect of this on income inequality.

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