Don't imagine China's troubles to be bigger than they are

Is the Chinese economy slowing down or melting down? You don't have to go far to find someone purporting to know a lot more about China than you do, who's making the most apocalyptic predictions.

And who knows? Maybe one day they'll be right. But I'll wait for it to happen before I start worrying.

By the same token, to say China is "slowing" seems a bit euphemistic. Being a developing country you can't say it's in recession the way you might say it of an advanced economy, because developing economies rarely experience an actual contraction in real gross domestic product.

At their worst they just grow at rates that, by their standards, are pretty bad, but by ours we'd be very pleased to have. In that sense it seems likely China is in or entering its own version of a recession.

Its rate of growth has been slowing for more than a year, it probably has more slowing to do, and with a bit of bad luck it could slow a lot more. At worst we're talking about growth in GDP slowing to maybe 4 per cent a year.

The biggest problem – as the doomsayers have long been saying – is the "overhang" from China's long-running real estate boom, in which far more apartments were built than there were people wanting to buy them.

Now housing construction has come to a halt in various parts of China, and it won't resume until the existing stock of empty homes is finally sold off. That could take at least a year, probably two. So the economy won't start to pick up anytime soon.

Limited housing construction means weak or declining growth in the manufacture of housing materials such as crude steel, cement and plate glass.

That's not the whole story, but it does mean the weakness is concentrated in construction and manufacturing, which just happen to be the main components of "industrial production" – an economic indicator the world's financial markets pay great attention to, not least because it's published monthly.

Trouble is, industrial production ain't easy to measure. It's particularly hard to do in developing countries, which don't have the bureaucratic infrastructure we have and where the shape of the economy keeps changing, not to mention the extra problems in measuring it monthly rather than quarterly.

This has prompted some in the markets to suspect a conspiracy rather than a stuff-up, and allege the Chinese authorities are making the numbers up. They may not be as reliable as we'd like, but don't believe that.

Another thing to remember – as people in the market tend to forget – is that industrial production accounts for only about 45 per cent of Chinese GDP. The remaining 55 per cent is in a lot better shape, as a Reserve Bank assistant governor, Dr Christopher Kent, argued in a speech this week.

By the way, if you're looking for someone to trust on China you could do worse than our central bank. It's well aware of the importance of China to our international prospects and so puts a lot more personpower than most into studying it: six or seven economists in Sydney, plus another two attached to our embassy in Beijing.

Kent says that although the weakness in China's property and manufacturing sectors is clearly of concern to commodity exporters like Australia, there are a number of countervailing forces supporting broader activity in China.

"First, growth in the services sector [worth about 45 per cent of GDP] has been resilient, and should continue to be assisted by a shift in demand towards services as incomes rise," he says.

"Second, growth in household consumption has also been stable in recent quarters, aided by the growth in new jobs. Of course, such outcomes cannot be taken for granted; if the industrial weakness is sustained, it might eventually affect household incomes and spending.

"Third, Chinese policymakers have responded to lower growth by easing monetary policy [access to loans] and approving additional infrastructure investment projects.

"They have scope to provide further support if needed, although they may be reticent to do too much if that compromises longer-term goals, such as placing the financial system on a more sustainable footing."

So what does this mean for us? The substantial slowing in industrial production has contributed to the further decline this year in the prices we get for our exports of coal and iron ore. (Of course, the bigger reason for the lower prices we're getting is the substantial increase in the supply of these commodities from places such as Australia.)

Kent says that what transpires with China's industrial production, and in Asia more broadly, will have a big influence on how much further commodity prices fall.

And the changing nature of China's development – a higher proportion of services and lower proportion of goods – limits the potential for commodity prices to go back up.

But here's the good news: Kent reminds us that the shift in demand towards services and Western agricultural products in China and Asia more broadly presents new opportunities for Australian exporters.

As recently as the mid-noughties, China's GDP was growing at the rate of 10 per cent. This is why money-market types are shocked to hear it's now growing by only 6.5 per cent, let alone 4 per cent.

But this just shows that even money-market types can be innumerate. As the distinguished former economic journalist Anatole Kaletsky has reminded us, China's GDP today is $US10.3 trillion ($14.5 trillion).

In 2005 it was $US2.3 trillion. So even just 4 per cent of $US10.3 billion is much more than 10 per cent of $US2.3 trillion.

To the Chinese, what matters most is the rate at which GDP is growing. To the rest of us, however, what matters is the size of the absolute addition the Chinese are contributing to gross world product.

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Terrorism: we must learn to think like economists

I've spent a lot of my life arguing that the hard-headed "rational" analysis so beloved of economists needs to be tempered by human emotion. But it also works the other way: sometimes we need to curb our emotional reactions and force ourselves to think coolly about what we really want and the most sensible ways to go about getting it.

I think this every time we're faced with another terrible act of terrorism. The first emotions are shock and horror, soon followed by a desire to hit back, to find a government to blame and demand action from. Promise us this will never be allowed to happen again.

Such reactions are only human, but when we surrender to them, we leave ourselves open to manipulation by the unscrupulous – and I don't just mean the terrorists.

But that's a good place to start. Terrorism is practised by the weak to get under the guard of strong. Their goal is not so much to terrify us and weaken our resolve as to provoke us into doing something stupid; something that damages us and benefits them.

Vengeance, retaliation, belligerence – these are common emotions at times like this, particularly among men. The great temptation at present is to send all our military might to the Middle East and defeat these forces of evil once and for all.

But how many times have we tried that without it working?

It's not easy to defeat your opponent so completely that no problem remains. It's much easier to make a strike that doesn't fix anything and actually makes things worse.

It never crosses the mind of the bellicose among us that the other side may be hoping to provoke us into hitting back. Why? To make them into martyrs, to show it's Muslims against the world, and to win them support from young potential fighters or terrorists in our midst.

Even the heroes who indulge themselves by shouting at women wearing headscarves are helping the side they hate.

It's arguable that, in its desire to punish someone after the terrorist strikes of September 11, 2001, the US has made things worse for itself and the rest of us. It's doubtful how much lasting benefit will result from all the lives lost and money spent in Afghanistan.

And the decision to invade and occupy Iraq has achieved little, but has destabilised long-standing enmities in the Middle East, greatly increased hatred of the US and, as the rise of Islamic State demonstrates, created a quagmire from which the Americans can't extract themselves.

No one's allowed to say it, but it's obvious: every time Australia muscles its puny way into these problems on the other side of the world – as if the Americans and Europeans need our help – we increase the risk of terrorism Down Under.

It's funny that the people who worry most about the "unsustainable" growth in government spending, tend to worry least about ever-increasing spending on defence, policing, security and surveillance.

Years of contact with economists has made me hyper-conscious of people using the media to push their vested interests. Almost all the alleged terrorism experts broadcast by a wide-eyed media at times like these seem to have a single message: do more, spend more. Oh, the risks we face.

All the understandable attention the media devote to terrorist attacks, anywhere in the world, can't help but leave us with an exaggerated impression of the risk of such an attack happening here.

A few years ago, Mark Stewart, a professor of civil engineering at my own University of Newcastle, estimated that the risk of an Australian being killed in a terrorist attack is one in 7 million each year, which is about the same as the risk of being struck by lightning.

It's not possible for our politicians to guarantee nothing bad will ever happen to us. But it is possible for them to cover their backsides by spending lots of money, progressively diminishing our freedoms in the name of protecting them, and putting on a show at airports.

A timely article in this week's issue of The Economist says that "a lot of what passes for security at airports is more theatrical than real".

Despite the likelihood that the recent Russian plane crash over the Sinai desert was caused by a bomb in the hold, attempts to blow up airliners are quite rare, it says. And the enhanced airport security introduced after 2001 has played no role in thwarting any attacks.

The ban on carrying liquids on board was introduced in 2006 after a plot to bring down several planes crossing the Atlantic was foiled thanks to a tip-off. In the time since then, nobody has been caught trying to get liquids on board to combine into a bomb.

Nor have any would-be bombers been intercepted since the requirement for passengers to remove their shoes was brought in, after a shoe bomber trying to set off an explosion was subdued by passengers.

The US Transportation Security Administration has a budget of more than $US7 billion ($10 billion) a year, but this year government inspectors succeeded in getting fake bombs and weapons through the screening process in 67 out of 70 tests in airports across the US.

So maybe no passengers have been caught doing the wrong thing because the security is such an effective deterrent, or maybe it's largely a showy waste of our time and money.

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How to fix everything: cut my tax

If I was on a mission to make big progress in increasing productivity and participation in the workforce, I wouldn't start with tax reform.

That the people who profess to be so concerned about productivity and participation have started with tax reform does make you wonder about their motivations. Especially when you realise that the primary beneficiaries of the particular reforms the urgers are seeking would be their good selves.

The motives of the Business Council and other business lobby groups are transparent: their high income-earners want to pay less tax, so are happy to see other people pay more.

To them, this is the attraction of using an increase in the goods and services tax to pay for cuts in income taxes.

The better-off (such as me) benefit because their higher rate of saving limits how much more GST they pay. They benefit even further if the cut in income tax is shaped in a way that favours high income earners.

Powerful people pursuing their self-interest is hardly surprising. Nor is seeing them seek to disguise their self-interest with happy chat about improving incentives to "work, save and invest" and professing to be terribly concerned that Oz will miss out on foreign investment or that all our top executives will be lured away by American corporations.

But if, as a would-be reformer, I did get down the to-do list as far as taxation, what "reforms" would I make?

First, I'd remember that all the bracket-creep we've subjected ourselves to in recent years is the standard way governments achieve a recovery in tax collections after they find they've earlier gone overboard with tax cuts and tax breaks - as we did in the first stage of the resources boom.

I'd remember that Treasury has overstated the extent of bracket creep because its projections assumed a much higher rate of wage growth than has transpired. It's true, however, that bracket creep is regressive, hitting people on the lower tax rates proportionately harder than people whose incomes have reached the top tax rate.

So if I felt it was time to ease up on bracket creep, I'd do it simply by lifting all bracket limits bar the top one by the same percentage, determined by the rate of price (not wage) inflation over the period. This would yield a quite noticeable weekly saving to workers.

That is, I'd belatedly do what in an ideal world I should have been doing once a year: indexing the tax scales to price inflation.

What I wouldn't do is con the punters by using the regressiveness​ of bracket creep as cover for a tax cut biased in favour of high income-earners (particularly when the earlier tax cuts and tax breaks the punters have been paying for were themselves biased in favour of high income-earners).

Second, to cover the cost of this tax cut - and possibly also to increase our tax-raising capacity to cover the future growth in health and education spending Treasury is always agonising over in its intergenerational reports - I'd increase not GST but a uniformly applied land tax (which could apply to the same tax base as local government rates).

Why? Partly because GST is a regressive tax, whereas land tax is progressive, hitting higher-income households proportionately harder than lower-income households.

Do that and the need to "compensate" low income-earners disappears - though it would be necessary to institute reverse-mortgage arrangements for asset-rich/income-poor oldies.

It would also remove the government's temptation to short-change the punters by double-counting the return of bracket-creep as compensation.

Increasing land tax would mean the reform package made the tax system fairer rather than less fair - surely an important goal of honest tax reform.

As well, universally applied land tax is more efficient than GST in that, as every economist is supposed to remember, it would do less to distort people's decisions about whether to "work, save and invest".

The argument that income from capital and, for high earners, income from labour, need to be taxed more lightly because globalisation has made financial capital and executive labour more mobile between countries, is widely used - especially by Treasury - to justify taxing consumption more heavily.

But how can these guys be fair dinkum in this argument when they're overlooking the ultimate immobile tax base, land?

Finally, though excessively generous superannuation tax concessions and capital gains tax concessions are overdue for reform, I'd use the proceeds to reduce the structural budget deficit, not throw them into the tax reform pot to help justify tax cuts for high income-earners.

It's arguable that budget repair is more important than tax reform.

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Go to ex-bureaucrats' blogs for the good oil on policy

Dr Ken Henry, a former Treasury secretary, says he can't recall a time when the debate about public policies has been poorer. I can't either, and I guess the dreaded MSM - mainstream media - is part of the problem.

But if the challenge of digital disruption has tempted the mainstream to devote more time to political colour and movement and less to debating government policies, there's one respect in which the internet has made things better.

The advent of blogging has given anyone who wants to the ability to air their thoughts to the world. A lot of blogs come under the heading of you're-entitled-to-your-opinion, but sometimes they're written by people who know a lot more about the topic than most of us and have a valuable contribution to make.

That's particularly true when academics take to blogging. One of the earliest bloggers about economic policy  was Professor John Quiggin, of Queensland University. Other high quality Australian blogsites are Club Troppo, Core Economics and, for the more libertarian, Catallaxy Files. (There was a blog called Ross Gittins, Corrected but they seem to have given up.)

The best academic blogsite is undoubtedly the uni-sponsored The Conversation. To have all those academics writing short, timely, readable pieces in their area of specialty is an invaluable contribution to the policy debate.

And then there's the blog of the former bureaucrat John Menadue, called Pearls and Irritations. Menadue brings in other contributors, and his blog is the place to go to see ex-bureaucrats casting a critical eye over present government policy.

These guys know where the bodies are buried, and no one sees through the political smoke and mirrors  more easily than they do.

Earlier this year Menadue teamed up with the former econocrat Dr Mike Keating to instigate a special series on the many challenges facing the government today, called Fairness, Opportunity and Security, with a wide range of contributions from ex-bureaucrats (including Stephen Fitzgerald, David Charles, Andrew Podger and Jon Stanford), academics (including Michael Wesley, Ian Marsh, Ian McAuley and Julianne Schultz) and academics who've spent time in government (including Ross Garnaut, Glenn Withers and Stuart Harris).

Now Menadue and Keating have turned the series into a book of the same name, published by AFT Press, which they asked me to launch last week. It covers 13 topics ranging from the role of government to the economy, foreign policy, health, the environment and Indigenous affairs.

In his discussion of the way vested interests seem to have excessive influence over policymaking, Menadue notes the remarkable rise of the lobbying industry, estimating there are now more than 1000 lobbyists operating in Canberra.

"The health 'debate' is really between the minister and the Australian Medical Association, the Australian Pharmacy Guild, Medicines Australia and the private health insurance companies," he writes.

"The debate is not with the public about health policy and strategy; it is about how the minister and the department manage the vested interests."

Menadue says much of the policy skills in Canberra departments have been downgraded and policy work is contracted out to accounting and consultancy firms. Policy work within the government is now undertaken more in specialist organisation such as the Productivity Commission.

"Departmental policy capability has been seriously eroded. That is the real story behind the problems of the pink batts scheme."

As for the "inexperienced and young ministerial staffers", they're "much more likely to listen to vested interests".

On foreign affairs and internal security, the blog collection says we've become overdependent on the United States at the expense of our relations in our region. As Paul Keating once said, we should be "finding our security in, not from, Asia".

In dealing with the threat from terrorism, "a balance needs to be struck between national security and the freedoms essential for a civil society, including the humane treatment of refugees. The politicisation of security has arguably made us less safe."

On Medicare we're told it "has stood the test of time but it now represents the single biggest budgetary challenge and it is over 30 years since it has been seriously reviewed and reformed".

On superannuation, Andrew Podger, former head of various government departments and now a professor at the Australian National University's Crawford School of Public Policy, makes a plea for considered and balanced reform rather than piecemeal tinkering.

You'll go a long way before you find someone providing a more authoritative, independent and sensible commentary on budget repair and other fiscal matters than Mike Keating, former head of the Finance department and Prime Minister's and Cabinet.

In this book he has hardheaded things to say about the dream of lower taxation, which "has been embraced by all political parties without any evidence that, given our already low starting point, less taxation will in fact lead to higher economic growth, let alone pay for itself".

He quotes John Howard saying that tax cuts should be considered only "after you have met all the necessary and socially desirable expenditures".

All the evidence is that these spending demands, even if efficiently funded, are most unlikely to be fiscally sustainable without a modest increase in taxation relative to gross domestic product.

"Indeed, Australia already has lower taxation than almost any other advanced nation, but we aim to provide the same level of public services and welfare as the others," he writes.

"Thus the biggest challenge facing modern governments is the gap between expectations on them and their capacity to deliver.

"In these circumstances, encouraging unrealistic expectations of tax cuts is only making government more difficult."

Reading this collection of blogs leaves you with the impression the good bureaucratic advice our successive governments have needed to do a better job of running the country now resides outside the public service, in the minds of the retired bureaucrats who're from the days when they were expected to know about policy.

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We can grow GDP if we stop growing natural resource use

Some things are more important even than the fate of the goods and services tax. A question I regard as just a tiny bit more significant to our future is whether we can continue increasing our population and material standard of living without doing irreparable damage to the natural environment.

Few of us noticed in all the excitement over tax reform, but last week we made a big step forward in answering this question. The CSIRO unveiled the results of a ground-breaking, two-year project – the Australian National Outlook report – in which it integrated a model of the economy with no less than eight models of different aspects of the global and domestic natural environment in which the economy exists.

So, is ecologically sustainable growth possible? Is it possible to "decouple" continuing economic growth from continuing environmental vandalism?

It depends on what you mean by "growth". There's enormous confusion on this point because what economists take the word to mean is not what scientists take it to mean.

What scientists mean by growth is growth in the "throughput" of natural materials and energy – using those resources to generate economic activity and, in the process, turning them into various forms of pollution and other waste.

They point out that such growth simply cannot continue indefinitely because the natural world – the global ecosystem – is of fixed size. And they have to be right because they're merely stating the first law of thermodynamics.

But that's not what economists mean by growth. They mean an increase in gross domestic product, most of which is cause by increased productivity (efficiency). It may or may not involve an increase in the economy's throughput of natural resources.

So what does the CSIRO's modelling say about whether we can continue to grow without inflicting further damage on the environment?

It says GDP can continue growing strongly, but throughput of natural resources can't. So the people who want continued growth in GDP win, but so do those saying ever-increasing use of natural resources must stop.

Since no one knows the future, CSIRO's economists and scientists ran through their super model 18 different scenarios covering different rates of growth in the global population, different degrees of global action to restrain climate change and a range of differing development in Australia and its economy.

All 18 scenarios project continuing strong growth in Australia's population and GDP out to 2050. But get this: only three of those scenarios also saw improvement or no further deterioration on the model's three key indicators of environmental health: emissions of greenhouse gases, water stress, and loss of native habitat.

As well, two of the three scenarios see no increase in the economy's annual throughput of natural resources, while the third projects a fall in material throughput of 38 per cent.

All this says ecologically sustainable growth and decoupling do seem to be possible, provided the world gets its act together.

The good news is that the model's results don't rely on "technological optimism" (don't worry, market forces will call forth a technological solution to every problem before the proverbial hits the fan) but nor do they require that we renounce our materialist ways and become greenie vegan mud-brick makers.

We don't need to do anything we don't already know how to do and, in many cases, have already begun doing. We just need to do a mighty lot more of it.

The bad news is that we can't do it on our own. To achieve improvement in the key environmental indicators and a fall in material throughput we need effective international action to limit the world's population to 8 billion in 2050 and limit global warming to 2 degrees in 2100.

This would require "very strong" global and Australian effort to reduce greenhouse emissions.

The two other environmentally not-so-bad scenarios – involving world population growing well beyond 8 billion and global warming limited to 3 degrees – would require "strong" global and Australian effort to reduce emissions.

Strong translates as a worldwide price per tonne of carbon dioxide emissions of $US30 ($42) in today's dollars; very strong translates as $US50 a tonne.

These world prices would be applied in Australia. But we'd have a comparative advantage over many countries that would reduce the carbon price's adverse effects on our economy: we could achieve up to half our required reduction in net emissions by "carbon sequestration" – reforestation of cleared land, either with one species of eucalypt (to maximise sequestration) or a range of eucalypts (to also restore native habitat).

At these carbon prices, our farmers could earn up to five times what they make from using the land to produce beef.

Our greenhouse emissions per person would fall from five times the global average in 1990 to below average by 2050.

Our biggest problem would be avoiding water stress, particularly because reforestation would add to the problem. The price of water for agriculture would be a lot higher and, in the cities, we'd have to do a lot more desalination and water recycling for industrial use.

I don't regard this as the last word on the subject. All modelling is far from infallible and this exercise is no different. The good thing is that a last we've made a start at reconciling our materialist ambitions with the constraints imposed by the natural environment we hope to continue living in.

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Tax reformers forget budget repair

Don't say no one warned you. As finally the nation focuses on tax reform, something is quietly slipping out of our grasp: the return to a balanced budget.

How so? Short answer: an annoying little thing called opportunity cost. Long answer: tax reform and budget repair are, to a significant extent, in conflict. The more we get of one, the less we get of the other.

So which does the government, its big business urgers and most economists want more? The choice will be most excruciating for Treasury.

The first reason for doubting we'll ever see a return to structural budget balance starts with simple arithmetic. For tax reform to have no direct effect on repair of the budget, the total reform package needs to be "budget neutral": its net changes on the revenue side should exactly offset its net changes on the spending side.

But major, potentially unpopular tax reform doesn't work that way. In practice, governments need to minimise the number of net losers by giving away more than they take.

John Howard's package introducing the goods and services tax in 2000, for instance, was heavily budget negative. He'd taken the precaution of saving up, so to speak, to pay for disproportionate tax cuts by amassing huge bracket creep, having avoided tax cuts for five or six years.

Of course, he had the budget well back into surplus by then and could take the hit without causing concern.

Nothing about Malcolm Turnbull's rhetoric suggests he's headed for a budget neutral package. He's been assuring his right wing that the package won't involve any net increase in the overall tax take.

But if it's revenue neutral rather than revenue positive, that means it has to be budget negative.

Why? Because the package will need to compensate low-income earners via increased spending on pensions, the dole and family allowances.

And if the premiers aren't to oppose the reform package, the feds will need to pay a fair proportion of the GST proceeds to the states. This would represent a decrease in Tony Abbott's $80 billion in prospective budget savings from cuts to the states' grants for schools and hospitals, already in the budget's forward estimates.

The second reason for doubting the budget will ever be repaired is that much of the present deficit is structural rather than cyclical. Turnbull has been saying the budget will return to surplus once the economy gets back to trend growth.

Sorry, Malcolm, not right. By definition, to say we have a structural deficit – as Treasury does in each year's budget papers – is to say the budget will still be in deficit even when we've returned to the normal part of the business cycle.

Structural deficits are the cumulative effect of past unfunded decisions to cut taxes or increase spending. This may not have been obvious at the time if the economy happened to be booming, giving you a big cyclical surplus to hide your transgressions.

This is why so much of our present structural deficit is owed to the decisions made by the Howard government during the first stage of the resources boom, including the eight successive tax cuts and, notably, Peter Costello's unsustainably generous increase in superannuation tax concessions in 2007. Also, Howard's halving of capital gains tax in 1999 (which has done so much to fuel negative gearing).

Labor's unfunded spending on the national disability insurance scheme and the Gonski school funding reforms have added to the structural problem laid by the Coalition, though much of this spending is to come.

Apart from allowing bracket creep, the only way to eliminate a structural deficit is via explicit cuts in spending and "tax expenditures" (special tax breaks), and explicit tax increases.

With tax cuts and tax expenditures playing such a big part in creating the structural problem, to resolve to fix it solely via spending cuts is a recipe for failure. That's the lesson of last year's disastrous budget.

The obvious way to begin eliminating the structural deficit is to reverse at least some of the irresponsible tax expenditures that gave rise to it. However, if Turnbull summons the courage to act on super and capital gains, it's likely he'll use the proceeds to make his tax package look fairer, not to cut the deficit.

The third reason for doubting we'll ever see budget repair also concerns opportunity cost. Even a leader as popular as Turnbull has a limited supply of political credit to draw on.

The more points he uses on the unpopular elements of his tax reform package, the fewer are left to cover the unpopular measures needed to get the budget back to balance.

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CSIRO fills Treasury's gap on environment modelling

After Treasury's hopelessly inadequate attempt to peer into the future in its intergenerational report earlier this year, just look at the far more fair dinkum future-viewing exercise that CSIRO unveiled on Thursday.

Treasury's effort was little more than a propaganda exercise about the need to restrain government spending, and showed clear signs of government interference. It was widely criticised for purporting to tell us what could happen to the economy over the next 40 years while making no allowance for the effects of climate change and other environmental problems.

By contrast, CSIRO's peer-reviewed modelling exercise attempts to look at what may happen to the economy out to 2050, after accounting for the economic effects of climate change – and our efforts to reduce it – plus other environmental problems such as energy use, water use and use of other natural resources.

This attempt to integrate changes in the natural environment with standard economic modelling is a heroic effort, the first time to my knowledge it's been attempted for our economy.

It's contained in CSIRO's first Australian National Outlook report, but also reported separately in this week's issue of the prestigious scientific journal, Nature.

The project was directed by Dr Steve Hatfield-Dodds, a former Treasury economist now with CSIRO, with participation by another three economists and 13 scientists, mainly from CSIRO.

The question they sought to answer was whether the mounting ecological pressures in Australia can be reversed while our population continues growing and our material living standards continue rising.

To put it another way, can economic growth be "decoupled" from natural resource use and environmental stress?

The modelling takes a fairly conventional "computable general equilibrium" model of our economy, but surrounds it with eight other models of different aspects of the environment – global climate change and economic growth, water use, energy use, transportation, land use, material flows and biodiversity – which have effects on the economy.

But can any person or model accurately predict what will happen in the future? Of course not. So the exercise identifies 18 different plausible "scenarios" of how things may unfold and runs each of them through the nine-model set-up.

Each scenario combines differing global drivers of change with differing domestic drivers. The global drivers cover differing rates of growth in the global population by 2050 – it may grow to 8 billion, 9 billion or 11 billion – and differing rates of greenhouse gas emission.

Limiting global warming to 2 degrees above pre-industrial levels by 2100 would require "very strong" efforts to "abate" (reduce) emissions. Limiting it to 3 degrees would require either a "strong" abatement effort if the global population was allowed to grow to 11 billion, or a "moderate" effort if the population grew only to 9 billion.

That leaves "no abatement action", with the global population growing to 11 billion and global warming reaching 6 degrees. Gasp.

The domestic drivers of change cover differing degrees of improvement in agricultural productivity, differing land-use changes from the development of reforestation markets for sequestration of carbon dioxide or for protection of biodiversity, individuals' take-up of opportunities to use energy and water more efficiently, how much of our improving productivity we take as reduced working hours rather than higher real incomes, and how much of our consumer spending we devote to buying "experiences" rather than goods.

(Turns out those last two drivers made little difference to environmental outcomes, according to the model.)

It's assumed that Australia's abatement effort is at the same rate as the global effort. Up to half our net reduction in emissions is achieved by "carbon sequestration" – withdrawing carbon dioxide from the atmosphere and storing it in plants – achieved by reforestation of cleared land.

So, we build this amazing nine-model model, then run each of the 18 different scenarios through it. What results do we get?

In all scenarios, the economy and living standards are projected to grow strongly. The value of economic activity (gross domestic product) is projected to rise 10-fold over the 80 years to 2050 (the exercise actually starts in 1970, with actual data up to 2012).

This increase in GDP is driven by a 2.9-fold increase in population, leaving a 3.2- to 3.6-fold increase in GDP per person.

On some scenarios, net greenhouse emissions fall to zero or lower by 2040. From four times the global average today, our emissions per person could fall below the global average by 2050.

Apart from reforestation, emission reduction comes from reduced emissions (within Australia, not elsewhere) and from the economy's reduced resource-intensity (that is, fewer natural resources being used to generate each dollar of GDP).

National water extractions are projected to maybe double in 2050, but up to half this increase could be met by desalination in coastal cities and water recycling for industrial use.

Water stress – seen in rain-fed water use in water-limited catchments – improves or is stable in seven of the 18 scenarios.

Pressures on biodiversity (preservation of species) could also be reduced despite economic growth and increased agriculture. But carbon and biodiversity tree-planting could increase the pressure on river-based water systems.

Overall, 13 of the 18 scenarios show improvement in a least one environmental indicator, but only three – each requiring "strong" or "very strong" abatement effort and development of reforestation markets – show improvement in all three environmental indicators.

So the modelling suggests economic growth can continue without worsening – and even while improving – pressures on the natural environment, but only if we and the rest of the world greatly increase our efforts to reduce emissions.

Now, I should warn you that modelling exercises – economic and scientific – are always subject to limitations and open to criticism. They rely on many assumptions and are widely misused by vested interests.

I'm sure in 20 years' time, this CSIRO modelling will look very crude. Right now, however, it's a wonder of the modern world.

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LAUNCH OF BOOK BY MENADUE AND KEATING

Sydney, Thursday, November 5, 2015

Paul Samuelson, the famous American economist, is said to have remarked that the stockmarket has predicted nine of the past five recessions. I thought of that this week and decided the Canberra press gallery could top it: the gallery has predicted nine of the past two early elections. They were at it again last weekend, reporting that, with the Coalition now riding high in the polls, serious thought was being given to calling an election - per force a double dissolution - early next year. It was an unconvincing proposition and, perhaps fearing that election speculation wouldn’t help restore business confidence, Malcolm Turnbull quickly scotched it, saying we could expect the election to be when it was supposed to be, in September or October next year.

The sub-title of the book whose launch we’re here to celebrate is, Filling the Policy Vacuum. The media have an important part to play in filling that vacuum - and maybe in having helped to create it in the first place. At present, what’s filling the vacuum - that absence of serious and informed discussion about the many policy issues the government should be grappling with - is what’s called “race-calling” - who’s winning, who’s losing, who’s facing leadership rumblings from the backbench and who’s planning to call an early election.

The gallery loves writing this stuff - it’s much easier and more interesting than discussing policy issues. And the gallery has discovered their editors back at head office love it. It’s reporting politics as though it was a form of sport - my team versus your team, who’s winning on the league table and worries about Plugger’s groin and whether he’ll pull up by Saturday. For most of our lives the newspapers have faced ever-increasing competition, not just from rival purveyors of news - radio, television and now the internet - but, more significantly, from the ever-multiplying ways for us to spend our leisure time rather than sitting down and reading the paper. Perhaps unsurprisingly, the media have reacted to this growing competition from rival forms of entertainment by making their political reporting more entertaining; by more race-calling and less earnest discussion of policy choices.

I don’t happen to agree with this approach. For one thing, politics as a fifth code of football doesn’t have that many followers. Most of us in this room would be avid followers, but most people out of this room aren’t all that excited by it. It may well be that all the argy-bargy the media focus on actually turns voters off politics.

Nor do I accept that policy discussion is inevitably on the dry side. Policy can be interesting, provided the journos know enough about the subject, have the confidence to sort the wheat from the chaff and highlight the parts of the policy choice that touch on people’s lives. The real problem is that good policy reporting and discussion requires harder work, not to mention greater specialisation.

In Ken Henry’s introduction to this book’s collection of 48 short policy discussions by 31 contributors covering as many as 15 policy areas - with all those contributors being well-known and well-respected former bureaucrats or academics (none more so than the book’s two editors and most prolific contributors, John Menadue and Mike Keating) - Ken says he “can’t recall a poorer quality public debate, on almost any issue, than we have had in Australia in recent years”.

There may have been a worse time in the past but, like Ken, I can’t remember it. In this talk I could try to come to grips with all the pertinent and challenging things those many authors have to offer on those many problems we face at present, but I’ll content myself with saying a little more about how this policy paucity came about and how the vacuum could and is being filled.

I’ve already acknowledged the part the news media have played in creating the vacuum and filling it with dross. As Michelle Grattan wrote in a piece published on The Conversation website last Saturday (October 31), “if we are talking about improving and enhancing public policy and the debate around that, the media have a significant role to play. They provide prime routes by which information about policy is disseminated; they are also conduits for the ideas being thrown up from these other players”.

It’s easy - and probably correct - to attribute part of the legacy media’s deterioration in performance to their preoccupation with finding a continuing place in the world of the internet, increasingly accessed by apps on mobile phones.

But I want to make the point that, from a policy-debate perspective, digital disruption has brought pluses as well as minuses. People interest in finding thoughtful, well-informed, even expert policy discussion no longer have to rely on newspapers and magazines. They can find new sources of quality supply quite readily on the net. Chief among these is the aforementioned The Conversation. I think this is a wonderful development.

One of the problems with the policy debate has long been the paucity of the contribution to that debate by academics. The universities profess to want to contribute to the debate, but the plain face is their reward system effectively discourages it, overwhelmingly favouring research. Many academics don’t follow the policy debate; they write for publication in journals that aren’t much interested in practical, “applied” matters like policy discussion and, fearing criticism from their peers, they spend months perfecting an article before letting it see the light of day.

The genius of The Conversation is that it has reframed academic contribution to the policy debate as something the uni authorities smile on (because they fund the site) and as something that, because of the unavoidable time pressures, everyone accepts is quick and dirty, the very opposite to what a journal article is supposed to be. The proprietors of the site must have established for themselves a licence to extensively rewrite the turgid prose most academics have trained themselves to write.

Of course, The Conversation is just the biggest and most notable new digital contribution to the debate. Various local academics run their own blogs - John Quiggin is the oldest example - or contribute to high quality group blogs, such as Club Troppo and Core Economics.

Which brings us to blogs by former bureaucrats, the chief among which must surely be our own John Menadue’s Pearls and Irritations. All the pieces in the book are, in fact, invited contributions to the special series John and Mike Keating organised earlier this year on Fairness, Opportunity and Security. The 48 articles are still accessible on John’s blog, but as an oldie who usually prints off internet articles to be read on paper rather than screen, I hope this project of turning them into a book will make them even more accessible and more widely read. They certainly deserve to be.

In view of this policy vacuum needing to be filled, it’s really great to have John providing this new platform and encouraging former bureaucrats to use it. Never has their contribution been more needed. We independent media commentators do our best to evaluate the government’s performance, but there’s nothing like a former bureaucrat to be able to see through the smoke and mirrors and decipher the true position. I myself have been delighted to take full advantage of Mike’s superior understanding of budgeting and macro and micro-economic policy.

I should add that the Grattan Institute - itself composed mainly of former academics and bureaucrats - has made a useful contribution to filling the policy gap, as have the many former bureaucrats now kept busy in non-retirement at the ANU’s Crawford School of Public Policy - some of whom have contributed to this volume.

Since the extraordinary economic and political incompetence demonstrated by the Abbott government’s first budget, I’ve spent a lot of time thinking about who was responsible for its failure and the huge damage this did to the Abbott government’s policy performance in other areas. Was it the econocrats in Treasury and Finance, the people at the top of the spending departments, the government’s youthful private office advisers, the bum steer provided by the strangely constituted commission of audit (which was pretty much contracted out to the Business Council), or just the manifest personal deficiencies of Tony and Joe.

I’ve come to the conclusion that poor advice from the econocrats and the department heads can’t be absolved from some share of the blame. But this can be traced back to the fault of the politicians - Rudd and Gillard as well as Howard and Abbott. The shiny-bums are an easy target for all politicians and, in the case of the Coalition, a very senior bureaucrat told me that they hold public servants in contempt. I believe that year-upon-year of ever-higher “efficiency dividends” has robbed the econocrats and the spending departments of much of their ability to provide their political masters with good policy advice.

The new practice of new Coalition governments beginning their terms by arbitrarily sacking a number of department heads must surely be designed to encourage the others not to provide frank and fearless advice. The Liberals’ “revealed preference” seems to be that they don’t want policy advice from bureaucrats. We’ll make the policy, you just implement it.

I know it’s easy to develop quite unrealistic expectations of what Malcolm Turnbull even wants to change, let alone will see his way clear to. But, even so, I’m sure he must be better than this. He’s too smart not to want good quality and frank advice from his bureaucrats, and I think he’ll want a high quality, intelligent public debate about policy options.

In Michelle’s Conversation piece that I referred to earlier, she implied that one reason for the gallery’s less than inspiring performance on policy issues is the actions of governments of both colours and over many years in discouraging contact between bureaucrats and journalists. It wasn’t like that in the 1970s when she - and, a little later, I - first went to the gallery.

Michelle suggests that the gallery’s coverage of policy issues could be much improved - to the advantage of the government of the day - if contact between the gallery and fairly senior bureaucrats was restored. As she stresses, this wouldn’t be about leaks, but about officials with expertise providing journos with the context and detail they have at their fingertips.

If any politician is able to see the sense in such a proposal, it ought to be Malcolm.

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Why we're sure to be voting on a rise in GST

About a year ago, I began confidently predicting the Coalition would not be going to next year's election with any proposal to increase the goods and services tax. I've been tardy in advising you that, with the removal of Tony Abbott and the ascension of Malcolm Turnbull, that prediction has become, as George W. used to say, inoperative.

Indeed, I now confidently predict the Coalition will be seeking the voters' agreement to an increase in the GST.

Why the reversal? Turnbull doesn't have much choice but to run with a GST increase for pretty much the opposite reasons that Abbott had little choice but to avoid one.

Abbott and his treasurer, Joe Hockey, would love to have championed a GST rise – and, early in their term, fully intended to do so – but their disastrous first budget, with its blatant unfairness and broken promises, robbed them of their popularity, authority and trustworthiness.

They repeatedly demonstrated their inability explain complex and controversial policy proposals.

But the government's big-business backers – not to mention most economists – have convinced themselves the only cure for the sluggish economy is major economic reform, and top of their list is a cut in the rate of company tax, plus a cut in the top rate of personal income tax.

This is why they became so dissatisfied with Abbott and Hockey, and so expectant of better things from one of their own, Turnbull.

The whole country knows Turnbull will be a better manager of the economy than Abbott and that if this silver-tongued barrister can't "sell" economic reform, no one can.

So great is the confidence in the confident Turnbull that the best way for him to stumble would be to baulk at this challenge.

Trouble is, by the time he's knocked tax reform into political shape, it will have fallen well short of its proponents' grand vision, won't deliver the promised economic benefits and won't make much difference to anything, apart from making the tax system less fair.

Right now, Turnbull is grappling with the desired shape of the GST increase. My guess is he'll definitely want to increase the rate of the tax, and won't go through all the angst for a piddling increase to 12.5 per cent. No, he'll go all the way to 15 per cent.

Broadening the tax's narrow base is more problematic, as the academics say. My guess is he'll avoid the practical minefield of extending the tax's coverage to health and education (even though taxing private health insurance and private schools would do much to reduce the tax's regressiveness​), but may include financial services.

His big temptation will be to tax fresh food but, though this would greatly increase his takings, it would also greatly increase the tax's regressiveness (because low-income households devote a much higher proportion of their budgets to food than high-income households do) and thus require much of this gain to be returned as "compensation", while adding much agonising and indignation from the elderly.

Of course, the GST increase will just be part of a much bigger package of tax reforms. Since the object of the exercise will be to change the "mix" of taxation – increasing indirect taxes on consumer spending while reducing direct taxes on income – it will include big tax cuts.

Turnbull will learn from his predecessors' blunder and ensure his reform package looks fair by including imposts aimed mainly at high-income earners. If he decides to cut the top rate of income tax – benefiting just the wealthiest 3 per cent of taxpayers – he'll probably include a crackdown on superannuation concessions and discounted capital gains tax favouring the well-off.

He'd also want to throw in abolition of some inefficient state taxes, such as the stamp duty on insurance policies.

He's making it very clear that low- and middle-income families would be protected from the effect of the higher GST by adequate compensation, in the form of special increases in pensions, dole payments and family benefits. People on low wages would be compensated by tax cuts.

But just because Turnbull has the smarts, political credit and credibility to raise the GST and hope to keep his job, this doesn't give him a magic wand to wave away the iron laws of arithmetic.

The sad truth is that the untiring advocates of a higher GST have plans to spend the proceeds many times over. Big business wants to devote the proceeds to covering the cost of cutting the rate of company tax.

The nation's grossly over-taxed chief executives want to use the proceeds to cut the top rate of income tax – all to produce a flowering of innovation and agility, naturally.

Then there's the Treasurer and his department, who profess to want to use the proceeds to counter the effects of bracket creep on everyone paying less than the top rate.

And, finally, there are the premiers, who think they own the GST and want to use the proceeds to cover the ever-rising cost of their spending on schools and hospitals. In principle and in political reality – although not strict legality – the premiers have a veto over any increase.

As ever, they'll go along with the deal once they've extorted enough moolah from the feds. Right now, they're in negotiating mode.

But not to worry. St Malcolm has promised to square the circle.

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Econocrats propose same old answer to all problems

If Malcolm Turnbull wants policy reforms that make the economy more innovative and agile, he should think long and hard before accepting advice from the economists in Treasury and the accountants in the department of Finance.

If you want innovation and agility, the last people to whom you should look for help are the two professions that, in their approach to problems new or old, demonstrate minimal innovation or mental agility.

I wouldn't want to call them insane, but they certainly recommend the same solutions over and over, while expecting different results.

The trouble with both professions is that their expertise is so narrow: they know a lot about just one aspect of the problem and little about all the other aspects, which they tend to ignore - while failing to warn their clients to match their advice against the advice of experts in other areas.

In the case of economists, they know what the economy needs, but they don't know much about what the economy needs and, thus, how to go about getting it.

For instance, economists see consumption as "the sole end and object of all economic activity". So they're experts on consumption, are they?

Well, no, not really. They couldn't, for instance, tell you how to maximise the utility you derive from your spending on consumption. Not their department. Better to ask a psychologist.

Economists know that improving productivity is the key to achieving faster economic growth and ever-rising material living standards. In fact, in the long run productivity is "almost everything".

So, could you give us a list of 10 things we could do to lift productivity? Well, no, not really. We don't actually know much about how you get productivity, we just know it's a great thing to have.

Of course, we do know a key source of productivity improvement is technological advance. Great, so how does technological advance work? Sorry, we haven't studied it much. We did have a go at developing an "endogenous growth theory" in the 1980s, but we soon gave up.

So what exactly is economists' area of expertise? They'd never admit it, so I'll tell you: prices. They know heaps about how the price mechanism works (given a host of mainly unrealistic assumptions), but not much else.

To make it sound sexier they may tell you economics is "the study of incentives". But in the economists' lexicon, incentives is just a synonym of prices. That's because economics pretty much ignores anything that can't be quantified, so the only incentives economists are conscious of are monetary incentives.

This assumption - that the power of monetary incentives is quite unaffected any other motivations (e.g. Turnbull only knocked off Tony Abbott because prime ministers are paid more than ministers) - does much to explain why the solutions economists propose often work so badly, with so many "unintended consequences".

Note that, in the mind of an economist, things like taxes and wages are just prices. This does much to explain economists' apparent obsession with taxation. It's a government-controlled price that seems to have much to do with the things politicians worry about these days.

It's a way for economists to appear to have useful advice on problems they don't really know much about.

Q: How should we encourage people to work more? A: cut the company tax rate and the top rate on individuals.

Q: How should we encourage people to save more? A: cut the company tax rate and the top rate on individuals.

Q: How should we encourage people to invest more? A: cut the company tax rate and the top rate on individuals.

Q: How should we encourage innovation? A: cut the company tax rate and the top rate on individuals.

Q: How can we make the economy more agile? A: cut the company tax rate and the top rate on individuals.

In sum, their preferred advice on such questions is: get the [monetary] incentives "right" and stand back.

Anything more specific to suggest? Yes, prime minister. Increase the tax incentives for spending on research and development. Give more money to scientific outfits like the CSIRO.

But haven't you guys been advising governments for years to keep cutting R&D tax breaks and money to CSIRO? Yes, prime minister, but that was when we wanted to cut the budget deficit and didn't care how we did it. Then, we didn't give a stuff about innovation and agility.

How come your advice on tax reform invariably favours high income-earners? Because when you're giving advice on matters you don't know much about, it's much less critically scrutinised when it happens to favour the rich and powerful.

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