When judging recessions, depth matters more than length

With the publication this week of the latest “national accounts”, our situation is now clear: we’re not in recession, yet we are – but, in a sense, not really.

Confused? It’s simple when you know. One thing we do know is that the economy – as measured by real gross domestic product – will have contracted significantly in the present quarter, covering the three months to the end of September.

At this stage, the smart money is predicting a contraction – a fall in the production and purchase of goods and services – of “two-point-something” per cent, although there are business economists who think the fall could be as much as 4 per cent.

Recessions are periods when people cut their spending sharply, causing businesses to cut their production of goods and services and lay off workers. It’s mainly because so many people lose their jobs that recessions are something to be feared. But also, a lot of businesses go broke.

This means no one should need economists to tell them if we are or aren’t in recession. If you can’t tell it from all the newly closed shops as you walk down the main street, you should know from what’s happening to the employment of yourself, your family and friends. Failing that, you should know it from all the gloomy stories you see and hear on the media.

Have you heard, by chance, that NSW, Victoria and now Canberra are back in lockdown, leaving some workers with no work to do, and the rest of us unable to spend nearly as much as usual because we’re confined to our homes? You have? Then you know we’re in recession.

When the first, national lockdown began in late March last year, real GDP contracted by 7 per cent in the June quarter. That was the deepest recession we’ve had since the Great Depression of the 1930s.

But it was also the shortest recession we’ve had because, once the lockdown was lifted, the economy – both consumer spending and employment - immediately began bouncing back. As the Australian Bureau of Statistics revealed this week, the bounce-back continued in the June quarter of this year, which saw real GDP growing by a strong 0.7 per cent, leaving the level of GDP up 1.6 per cent on its pre-pandemic level.

All clear so far? The confusion arises only in the minds of those people silly enough to let the media convince them that, despite all the walking and looking and quacking they see before their eyes, a recession’s not a recession unless you have two consecutive quarters of contraction in GDP.

The size of the contraction is of no consequence, apparently, nor would be two or more quarters of contraction that weren’t consecutive. This is nonsense.

As my colleague Jessica Irvine has explained, this “rule” is repeated ad nauseam by the media, but has no status in economics. It’s a crude rule of thumb that’s frequently misleading. It’s in no way the “official” definition of recession.

But the consecutive-quarter rule is so deeply ingrained that it causes needless debate and uncertainty. Some business economists convinced themselves that this week’s figure for growth in the June quarter could be a small negative.

Oh, gosh! Since we know the present quarter will be a negative, that means we could be in another recession. Quick, get out the R-word posters.

But no. June quarter growth proved stronger than expected. Treasurer Josh Frydenberg couldn’t resist the temptation to declare there’d been no “double-dip recession”. Thank God!

But wait. The lockdowns could easily continue beyond the end of this month and into the December quarter. So we could have a second negative quarter on the way. Quick, bring back the posters and start writing the double-dip speech.

Sorry, this is not only silly, it’s got the arithmetic wrong. When the economy goes from growth to lockdown, you get a negative. But when, in the follow quarter, the economy merely stays in lockdown you get zero growth, not another fall.

The present lockdowns apply to a bit over half the economy. So, if the other half continues to grow, we will get a positive change in GDP during the quarter.

What’s more, if the lockdowns end sometime before the end of December, we’ll get a bounce-back in growth in that half of the economy, as everyone rushes out to start buying the things they were prevented from buying during the lockdown.

That’s what happened last time the lockdown ended; it’s safe to happen this time too. So it’s hard to see how we could get a second quarter of “negative growth” in the three months to New Year’s Eve.

We’ll learn what the figure was in early March, in good time for the federal election. Stand by for Frydenberg’s triumphant declaration that we’ve avoided a double-dip recession for a second time. He’ll turn the media’s consecutive-quarters bulldust back on them, and spin a story of great success.

But this will literally be non-sense. He’ll take a contraction in the September quarter of, say, 2 to 4 per cent – as big as the contractions that caused the recessions of the mid-1970s, the early 1980s and the early 1990s – and pretend it doesn’t count, simply because that massive contraction was concentrated in one quarter rather than spread over two.

He’ll con us into accepting that the depth of a slump doesn’t matter, just its length. More nonsense.

But there remains a respect in which, like the first dip, the second isn’t really a recession. What we had last year and are in the middle of right now aren’t recessions in the normal sense.

They’re artificial recessions deliberately brought about by governments to minimise the loss of life from the pandemic. They thus involve a degree of monetary assistance to workers and businesses unknown to normal recessions. This means they don’t take years to go away, but disappear in six months or so because of the speed with which the economy bounces back when the lockdown ends.

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If you want to shop in competitive markets, you’ll have to fight for it

The lockdown is dragging on so long and its end point is so uncertain that it’s easy to become anxious and despondent. That’s especially true of the young, who’ve had less experience of bad episodes eventually passing. The rest of us know they will, however long it takes. But it may help if we switch the focus to what we’ll do to make the world a better place once things return to normal.

One conclusion the young are justified in reaching is that the world is run by well-off older men (present company excepted) intent on making the world better for themselves, even if that comes at the expense of others.

A question for the coming federal election is which side is more likely to restrain the rich and powerful rather than help them in their quest.

It’s true that people near the very top have continued doing better, while the rest of us have had very modest pay rises. In healthy market economies, vigorous competition and continuous investment in better machines increases the productivity of workers, which is reflected in higher real wages.

There’s been very little of that over the past decade and one reason for this seems to be a decline in competition between the few big businesses that dominate so many of our markets.

When companies get bigger by taking over their competitors, this gives them more power to increase their prices and profits (and executive salaries) without them becoming more efficient or paying their workers more.

The list of Australian markets dominated by a few large firms is long, including banking, supermarkets, insurance, electricity and gas retailing, domestic air travel, pathology testing, mobile phones and internet service providers, not to mention internet search and social media platforms.

It may surprise you that, contrary to what happens in other advanced economies, companies seeking to merge don’t need permission from the ACCC, the Australian Competition and Consumer Commission.

Many choose to consult the commission, but if they press on with a merger the ACCC thinks will increase their “market power”, its only recourse is to take them to the Federal Court and convince it that the merger would “substantially lessen competition” in the future.

This isn’t easy. The executives generally assure the judges that something so dastardly has never crossed their mind, and their assurances are believed. The last seven times the commission has sought to get mergers blocked, it has failed.

It’s not the court’s job to come back a few years later and see if those assurances were honoured by the rich and powerful men whose evidence the judges found it so easy to believe.

So, in a speech last week, commission chair Rod Sims sought to start a public debate on “market concentration” and proposed that the proponents of mergers be legally required to notify the commission of their intentions, then wait for the deal to be assessed and cleared before proceeding. The proponents could appeal in court against any decision they didn’t like.

Sims says competitive markets work much better for consumers, and increase innovation and productivity.

“While the available evidence is not definitive, it appears that market power [to raise prices] is increasing in Australia. This trend has also been observed in many advanced economies, including by the International Monetary Fund,” he says.

“Without action, market power in Australia will become further entrenched; and will certainly not reduce.”

Market power is hurting Australians in many ways, he says. Consumers are paying more than they should for a wide range of goods and services.

It’s also “squeezing the incomes of farmers. For example, chicken growers and dairy farmers have little option but to sell their produce to large buyers with substantial bargaining power.” Farmers purchase many of their supplies from only a few big sellers.

“Many small businesses and farmers are largely reliant on Coles and Woolworths to access grocery shoppers ... This power imbalance places small businesses and farmers in precarious positions with consequent damage to our economy.

“In digital markets, we are exchanging access to our personal data and attention for so-called ‘free’ services, but have little choice, knowledge or control over how our data is being used.”

Now, if you’re sitting down, I’ll tell you something that will amaze. Jennifer Westacott, chief executive of the Business Council of Australia, can’t see what the fuss is about. She fears the proposed changes would be “another blow to investment”. (By which I assume she means businesses “investing” in the takeover of other businesses.)

As for Treasurer Josh Frydenberg, he has no enthusiasm for Sims’ reforms. He says the lockdown means we need to encourage business and growth, not throw up regulatory barriers. (I suspect we’ll be hearing a lot more of that convenient argument between now and the election.)

Do you see why Sims wants to start a public debate? If this issue is left for the Treasurer and the big-business lobby to sort out behind closed doors, nothing will change.

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Smaller Government push explains much of our pandemic fumbling

It’s right for our elected leaders to be held responsible for the failures that have led to the loss of lives and livelihoods in our struggle against the coronavirus. But let’s not fail to see the systemic failures that have led our governments – federal and state; Liberal and Labor – to fall short.

If you’re not looking for it – or don’t want to find it – it’s easy to overlook the inconvenient truth that decades of pursuit of Smaller Government have contributed greatly to the difficulty we’ve had controlling the spread of the virus and hastening the rollout of the vaccine.

Earlier this month, two economics professors, Steven Hamilton and Richard Holden, used two articles in the Australian Financial Review to lay much of the blame for delay in the rollout and in rapid COVID testing at the feet of the “medical regulatory complex”.

They criticised our TGA - Therapeutic Goods Administration – for being “persistently behind the curve – lagging months behind foreign regulators” in approving the various vaccines. The medicos should hardly need economists to remind them of the point they themselves dinned into the rest of us: the spread of pandemics is exponential, so a delay of just six weeks really matters.

So, if medical bureaucracies overseas can approve new drugs with expedition, why can’t we? And they can approve in-home rapid tests, but we can’t?

Because our standards are so much higher than theirs? Doubt it. More likely because we weren’t trying hard enough. Maybe the TGA was short-staffed or the government hadn’t approved enough overtime. As for the reservations about rapid testing, you wonder if it wasn’t a case of doctors trying to make work for doctors, not nurses or pharmacists.

Then there was all the chopping and changing over who should get the AstraZenica vaccine by ATAGI – the Australian Technical Advisory Group. It was narrow, inappropriate advice that failed to take account all the relevant considerations and did much damage to the rollout.

Maybe the government asked the wrong bunch of specialists, or gave them the wrong terms of reference. I’ve seen it suggested that a more appropriate committee had been abolished in cost-cutting by the Abbott government.

The Morrison government’s delay in acquiring sufficient vaccines seems to have arisen from a desire to limit the cost of the exercise, combined with an ill-fated preference for having the vaccine manufactured locally.

Much of our difficulty preventing leakages from hotel quarantine has arisen from cost saving: using ill-suited empty hotels would be much cheaper than purpose-building out-of-town cabin-style facilities, especially when you remember we won’t get another pandemic for decades. Maybe.

Similarly, outsourcing quarantine security to private contractors using casual, low-paid and untrained workers, who probably work at several facilities to make ends meet, saves money. The same way we use outsourcing to cut the cost (and quality) of so many public services these days.

At state level, stockpiles of personal protective equipment recommended by a committee charged with getting us ready for a pandemic were cut as a cost-cutting measure.

Wherever responsibility is shared between federal and state – which is most areas - you get cost-cutting, cost-shifting, game-playing and duck-shoving. The feds had huge success at shifting the blame for Victoria’s second lockdown to Dictator Dan, even though the great majority of deaths occurred in federally regulated aged-care homes.

As the royal commission found, the unending string of scandals in aged care arises from decades of trying to hold down the cost of care to the federal government. Knowing they’re not spending enough to fund decent care, the feds don’t dare to properly regulate the sector’s mainly for-profit providers.

But, since businesses are entitled to a reasonable return on their capital, turning the sector over to private providers adds another layer of cost. There’s little reason to hope their profit margins are covered by their greater efficiency in running institutions. They make room for their profit by cutting other costs.

Cost cutting is just one aspect in which the Smaller Government push has hindered our efforts to respond to the pandemic. Another is the longstanding rundown in the capability of the public service, especially its ability to give policy advice.

Who needs advice from public servants when, if the minister doesn’t know what to do, the politically ambitious young punks in the minister’s office will have plenty of ideas? Failing that, you can always commission a report from one of the big four accounting firms which, you can be sure, will tell you only what you want to hear. I doubt the health departments are immune from these weaknesses.

Of course, our pandemic problems are just the latest, most acute demonstration of the failure of the Smaller Government project, but that wider story’s a topic for another day.

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Morrison's surprise investment in a better class of economic debate

When he was appointed chair of the Productivity Commission, Michael Brennan looked to be just another political appointment by a government that disrespected the public service and was busily installing its own men – and I do mean men – to plum jobs and key positions.

Three years later it’s clear that, whatever Scott Morrison’s motives in insisting he be appointed, Brennan is his own man, with his own inquiring and “well-furnished” mind. His disposition is conservative and he’s expert in the neo-classical orthodoxy of economics.

He’s what Treasury-types used to call an “economic rationalist”. But Brennan is no narrow-minded dogmatist who, having discovered the truth, sees no need to look further. He’s learnt from behavioural economics and is interested even in “evolutionary economics”.

Brennan’s appointment to head the Productivity Commission coincided with the early departure of John Fraser as secretary to the Treasury and then-treasurer Morrison’s decision to replace Fraser with the chief of staff in his own office, Philip Gaetjens.

Fraser, you recall, had been hand-picked for Treasury secretary by Tony Abbott, after his first act as prime minister had been to sack the existing secretary, Dr Martin Parkinson, and several other top econocrats.

The fact that Brennan had previously worked for Liberal ministers, federal and state, and had once run for Liberal preselection, framed his appointment as political. What this misses, however, is that Brennan is his father’s son.

Geoff Brennan, an economics professor at the Australian National University, won an international reputation for his contribution to the theory of public choice. All professors have sharp minds; Brennan’s is sharper than most.

In all its previous incarnations, going back to the pre-Whitlam Tariff Board, the Productivity Commission has been a bastion of economic orthodoxy. Its influence on elite thinking played a big part in the transformation of the economy under Hawke and Keating.

It’s usually been led by neo-classical, rationalist warriors. Brennan fits the bill, but he’s far more open-minded, widely read and persuasive than his predecessors.

In a speech last week, Brennan noted that the commission will soon release research on working from home: what it might mean for cities, for our work health and safety regime, the workplace relations system; what it might mean for productivity.

“We analyse these things from an economic perspective,” he explained, “and our starting point is a fairly conventional neo-classical framework.

“The conventional economic framework is useful because it helps us think through the forces acting on wages, rents, productivity and – importantly – overall wellbeing. But I do think that to really understand the path of digital technology and its economic impact you really need to combine those traditional neo-classical insights with the insights gleaned from a more evolutionary approach.”

Eh? What?

“The evolutionary approach to economics – of which [Professor] Jason Potts [of RMIT University] is a leading practitioner – eschews that narrow profit maximising assumption in favour of the more realistic view that firms face uncertainty – both about the state of things and the future – and do their best to navigate their way through the fog.

“The evolutionary approach stresses the importance of variety – the idea that different firms make different bets based on their subjective hypotheses about what will work; with these experiments submitted to the test of the market and society.

“It stresses that variety can foster novelty. It is not an aberration, but that it’s actually fundamentally important – particularly in the early stages of a new technology.”

None of Brennan’s predecessors at the commission would ever have said anything like that. Recognise that the neo-classical model is just one way of trying to understand how the economy works, and that there are other, quite different ways of analysing economic activity that could add to our understanding of how it ticks? Never.

In an earlier speech, Brennan gave a warning about the relaxed approach of some to the massive build up in deficit and debt since the pandemic. All his predecessors would have shared that concern. But they would never have expressed the warning in such a well-reasoned way.

The new conventional wisdom among economists (to which I subscribe) is that high public debt doesn’t necessarily have to be paid back. It will decline in relative terms – relative to the size of the economy, gross domestic product – so long as nominal GDP grows at a faster rate than the rate of interest on the public debt – and, of course, so long as you’re not adding to the debt.

Brennan’s warning: “The risk in the public debate is that this insight – that GDP growth tends to exceed interest rates – is taken to imply something altogether different and much bigger: that debt and deficit no longer matter at all.

“That we can afford the next and the next ‘one-off’ rise in debt on the grounds that growth rates will continue to outpace bond yields . . .”

Brennan outlines various reasons for not being seduced by this life-was-meant-to-easy view, but focuses on the micro-economic case for caution. He notes, as economists do, that hidden behind the amounts of mere money being spent is the use of “real resources” in the economy. We can print as much money as we want, but what can’t be produced from thin air are the land and raw materials, capital equipment and labour that money is used to buy.

And there are physical limits on the extent to which real resources – as opposed to money – can be borrowed from the future. Real resources bought by the government are no longer available to be used by business for investment and innovation.

True. Good point. Surprise, surprise there’s no free lunch. But this tells me we should be trying a lot harder to ensure the money governments spend isn’t spent wastefully. We should spend on things governments are prepared to ask taxpayers to pay for.

What doesn’t follow is neo-classical economics’ implicit assumption that spending decisions made by the private sector are always superior to the things governments spend on.

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Working from home would be back to the future

By now it seems cut and dried. The pandemic has taught us to love the benefits of working from home and stopped bosses fearing it, so we’ll keep doing it once the virus has receded and the kids are back at school. Well, maybe, maybe not. Any lasting change in the way we work is likely to be evolutionary rather than revolutionary.

Productivity Commission boss Michael Brennan and his troops have been giving the matter much thought and, as he revealed in a speech last week, such a radical change in the way we work would be produced by the interaction of various conflicting but powerful forces.

After all, it would be a return to the way we worked 300 years ago before the Industrial Revolution. Then, most people worked from home as farmers, weavers and blacksmiths and other skilled artisans. And, don’t forget, by today’s standards we were extremely poor.

What’s made us so much more prosperous? Advances in technology. But technology is the product of human invention. That invention could have pushed our lives in other directions.

What underlying force pushed us in the direction it did? As the Productivity Commission boss was too subtle to say, our pursuit of improved productivity.

Productivity isn’t producing more, it’s producing more with less. In particular, producing more of the goods and services we love to consume using less labour. Why among the three “factors of production” – land and its raw materials, capital equipment and labour – is it labour we’ve always sought to minimise?

Because we run the economy to benefit ourselves, and it’s humans who do the labour. We’ve reduced physical labour, but now automation allows us to reduce routine mental labour.

(While we’re on the subject, note this. Many people think automation destroys jobs. But in 250 years of installing ever-better “labour-saving technology” we’ve managed to increase unemployment only to 6 per cent or so. That’s because automation doesn’t destroy jobs, it changes and moves them. From the production of physical goods to the delivery of human services. In the process, it’s made us hugely better off.)

It was the Industrial Revolution that increasingly drove us to the centralised workplace. Initially, the factory and the mine, then the office.

The move to most people working in a central location was driven by economic forces. Businesses saw the benefits – to them and their customers – of combining labour with large and expensive machinery, powered by a single source. Initially, steam.

“The factory provided a means for bosses to co-ordinate activity in real time, supervise workers and it also provided an efficient way to share knowledge – as did the office,” Brennan says.

So the central workplace reduced the cost of combining labour and capital, but did so by imposing transport costs – mainly on workers who had to get themselves from home to the central location and back.

For most of the 20th century, however, it got ever-cheaper to move people around, via steam, electricity, the internal-combustion engine and the aeroplane. So advances in transport technology reinforced the role of the central workplace.

For about the past 30 years, however, the cost of moving people around has stopped falling. “We seem to have hit physical limits on speed; and congestion has meant that today it takes longer to move around our cities than was the case a few decades ago,” Brennan says.

This, of course, is why we fancy the idea of continuing to work from home. It’s only advances in computing and telecommunications technology that have made this possible. The cost of moving information has plummeted, while the cost of moving workers – in time and discomfort – has gone up.

So, could it be that modern communications technology is set to drive us back to our homes?

Perhaps. But remember this. While the tiny proportion of people working from home has hardly budged over the past two decades, our capital city CBDs have become more significant as centres of economic activity and as engines of productivity improvement.

Here’s the catch. At the same time as information technology was improving, and the cost of communicating over distance was falling, the nature of work was changing. As machines have replaced routine tasks, modern jobs have come to require more open-ended decision-making, critical thinking and adaptability.

Experts think these quintessentially human skills are best developed and honed through face-to-face interactions, such as the serendipitous encounter or the tacit knowledge we absorb through observing those around us.

Get it? That many of us have come to prefer working from home (I’ve been doing it since 1990) is just one factor that happens to be pulling us in the direction of home. Other factors will keep pulling us into the office. Expect a lot of businesses experimenting with different mixes of the two.

Economic history suggests that what evolves will be the combination that maximises our productivity. Not just because bosses want to make bigger profits, but also because most people like a rising standard of living.

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How Morrison can get going towards net zero - if he wants to

Scott Morrison seems keen to keep his job as Prime Minister, but not so keen to do the job PMs are paid to do: make tough decisions in the nation’s interests. So it’s up to the rest of us to step into the breach. And when it comes to the decision Morrison fears most – getting to net zero emissions by 2050 – no one’s keener to help out than Tony Wood and his team at the Grattan Institute.

Wood begins where everyone with any sense begins: by noting that the best way to reduce emissions at minimum cost to the economy - and all the people in it - would be to introduce a single, economy-wide price on carbon emissions.

But the temptation to win elections with populist bulldust about “a big new tax on everything” proved too great and so, with that off the table, we must find other, more interventionist, sector-by-sector ways to skin the cat (many of them requiring additional government spending, which will have to be paid for somehow).

The basic strategy for reducing our emissions is clear: move from fossil fuels to renewable ways of producing electricity (plus the use of batteries to store it), then meet all other energy needs with electricity. In practice, it’s more complicated, of course.

Official projections foresee emissions from electricity falling substantially over his decade, while the next four largest sources of emissions either grow or, at best, plateau. Grattan is producing a series of five reports proposing relatively easy and obvious ways of achieving early reductions in emissions in each sector.

Its thinking is to get early progress because, even if we were to reach net zero emissions just before 2050, that wouldn’t be sufficient to stop the increase in the global average temperature being a lot greater than 1.5 degrees – which is about as much as we can take without major social and economic disruption, not to mention personal discomfort.

If we take as many easy shots as we can now, that buys more time for technological advances to help us with the harder stuff. Getting some momentum going should help build public acceptance of the need for more, as well as giving business a clearer picture of where we’re heading and the risks it runs if it ploughs on regardless.

In any case, the latest report of the UN’s Intergovernmental Panel on Climate Change isn’t likely to be the last telling us temperatures are rising faster than earlier thought. It wouldn’t be surprising to see the 2050 deadline brought forward.

Wood’s first report in Grattan’s five-part series covered the transport sector. It proposed measures to achieve an early move to electric cars, while we wait for hydrogen technology to help with heavier transport.

Wood’s second report, on the industrial sector, was released on Sunday. This covers emissions arising from the production of coal, oil and gas – as opposed to their customers’ use of their products – emissions from the mining and processing of other minerals and metals, and emissions from processing in manufacturing.

As well as burning fossil fuels to help extract fossil fuels, coal, oil and gas production involves “fugitive” emissions of greenhouse gases during the extraction process.

The sector’s emissions have increased significantly since our base year, 2005, mainly because of our foolish decision to permit three different companies to build huge liquefaction plants on an island off the coast of Queensland and turn us into one of the world’s largest exporters of liquid natural gas. Liquefaction, it turns out, involves massive emissions.

The entire industrial sector accounts for almost a third of our total emissions, which are projected to be little changed over the decade. The good news is that 80 per cent of its emissions come from just 187 large facilities. Most of these are subject to the federal government’s existing “safeguards mechanism”, which sets a baseline – or maximum - for each facility’s emissions.

So Wood’s chief proposal is for this mechanism to be modified and extended. Existing facilities should be required to use technologies now available to gradually reduce their emissions. New facilities should be required to meet benchmarks substantially lower than existing ones.

“From now on,” Wood says, “every decision to renew, refurbish or rebuild an industrial asset potentially locks in emissions for the coming decades. Getting these decisions right will be critical for reaching net zero.”

Of course, when it comes to the many facilities producing fossil fuels for export, their future prospects will be affected more by other countries’ climate-change policies than by ours. Good luck finding customers for fossil fuels as the reality of global warming catches up with them as well as us.

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Global warming is too 'wicked' to just muddle our way through

It’s probably always true that democracies take too long to accept the need to act decisively to avert foreseeable problems. We never do it well, but always manage to muddle through. We wait until the problem’s reached crisis point. Everyone’s panicking, and thus willing to accept the tough remedies needed. But I fear climate change is too “wicked” a problem to be solved this usual way.

An extra problem for Australia is that we have a government rendered impotent by its internal divisions. The good news – of sorts – is that when the captain of the ship goes AWOL, the crew take over. The premiers – Liberal and Labor – are stepping in to fill the gap. And business can see the writing on the wall and is taking evasive action.

It’s obvious the world is moving to renewable energy and, before long, oil, gas and coal will become “stranded assets” selling a product for which demand can only decline. Here and overseas, banks are worrying about the security of their loans to fossil-fuel businesses, pension funds and investment managers are worrying about their members’ distaste for investing in polluting businesses, and energy businesses such as AGL and now BHP are dividing themselves into good bank and bad bank, so to speak.

Much of the wake-up call to finance and business is coming from financial regulators. Our Australian Prudential Regulatory Authority (APRA) has initiated a climate vulnerability assessment for banks, encompassing scenarios up to 3 degrees of average global warming, and has issued draft guidance for companies to stress test their own finances against scenarios of up to 4 degrees warming.

But in the report, Degrees of Risk, released this week by the Breakthrough – National Centre for Climate Restoration, and written by David Spratt and Ian Dunlop, the authors warn that if by these actions the climate-risk regulators imply warming of 3 to 4 degrees is manageable, or could be adapted to, APRA risks doing more harm than good.

Why? Because with warming of that extent, it’s doubtful we’d still have any banks. The authors say scientists consider 4 degrees of warming to be an existential threat, incompatible with the maintenance of human civilisation. And 3 degrees would be catastrophic, perhaps leading to outright chaos in the relations between nations.

If warming was anything like that bad, applying “stress tests” and doing “scenario planning” would be largely irrelevant.

The authors quote one professor saying that a 4-degree future is “incompatible with an organised global community, is likely to be beyond ‘adaptation’, is devastating to the majority of ecosystems and has a high probability of not being stable”.

Another prof says “it’s difficult to see how we could accommodate 8 billion people or maybe even half that . . . it will be a turbulent, conflict-ridden world”.

Among other impacts, the authors say, 4 degrees would in the long run melt both polar ice caps, with a sea-level rise of about 70 metres. Even 3 degrees would be catastrophic and make some nations, and regions, unliveable.

The authors say most people don’t understand what “global mean [average] warming” implies. As a general rule, global average warming of 4 degrees – covering land and ocean – is consistent with 6 degrees over land (that is, warming over the ocean would be a lot lower, bringing the average down) and with average warming of 8 degrees over land in the mid-latitudes.

That, in turn, risks an average warming of 10 degrees in summer. Or perhaps 12 degrees during heatwaves. All this is packed inside a tolerable-sounding global annual average warming of 4 degrees.

The authors say that Western Sydney has already reached heatwaves of 48 degrees. Add 12 degrees to that and you get summer heatwaves of 60 degrees. Phew.

Now, remember that psychologists and communications experts have been warning climate change campaigners that, if they make their message too frightening, the reaction of many people won’t be to rush out and join Extinction Rebellion, but to close their ears and do nothing.

Remember, too, that the modelling and projections of the climate scientists are far from certain sure and, as with the virus modelling of the epidemiologists, are based on assumptions that keep changing as our understanding of the phenomenon improves.

For these reasons, the UN’s Intergovernmental Panel on Climate Change has long erred on the side of understatement. But the risk with all this is that sensible people with the best intentions – such as regulators of the financial system – don’t realise how bad things could get.

The authors of Degrees of Risk say the science of climate change is inherently complex because it describes the dynamics of a multi-dimensional, “non-linear” system, involving many sub-systems and networks of adverse “cascade effects”.

“Some responses to increasing levels of greenhouse gases are relatively linear and able to be projected well by climate models” but other responses are “non-linear, characterised by sudden changes, rather than smooth progress, which take the system from one discrete state to another, possibly with system cascades” where one change touches off a chain of changes.

“Factors contributing to this non-linearity include the existence of tipping points – polar ice sheets [melting], for example – where a threshold exists beyond which large, system-level change will be initiated, and positive feedbacks [that is, self-reinforcing loops] drive further change.

“In a period of rapid warming, most major tipping points, once crossed, are irreversible on human time frames”.

The authors’ message to regulators of the financial system is that the risk to banks and businesses at degrees of warming of anything like 3 or 4 degrees are huge, but so uncertain as to be unmeasurable. We need to act on the precautionary principle of significantly reducing emissions now, so we never get to find out how bad it could be.

The more prosaic message I draw is that we mustn’t kid ourselves that climate change is just another problem with unpopular solutions that we’ll muddle through as we always do.

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It's the rich wot get to complain and the poor wot get infected

If you’re anything like me, you’re getting mighty tired of lockdowns. I miss being able get out of the house whenever I choose, I miss going to restaurants and – my favourite vice – going to movies. That bad, huh? You’re right, I don’t have much to complain about. I don’t envy those having to school their kids while working at home – although I do miss seeing my grandkids in the flesh.

If you think I need reminding of how easy I’m doing it compared with a lot of others, you’re probably right. But I suspect that’s true of many of us, even those of us doing it just a tiny bit tougher than me.

Apart from those with kids to mind, the first hardship dividing line is between those of us easily able to work from home and those not. This probably means those still on their usual pay and those reliant on some kind of government support.

Even those unable to work from home but “fortunate” to work in an essential industry probably pay the price of running a much higher risk of getting the virus. And that without anyone doing enough to help them get jabbed.

Another divide would be between those in secure employment, with proper annual and sick leave entitlements, and the third of workers in “precarious” employment, most of whom are casuals rather than in the “gig economy”.

Having so many workers without entitlement to sick leave has been a burden for those involved and for the rest of us, namely an increased risk of being infected by someone who, needing the money, keeps working when they shouldn’t.

But though the dividing lines are different in a pandemic, the greatest divide of all is unchanged. As the old song says, it’s the same the whole world over, it’s the rich wot gets the pleasure, it’s the poor wot gets the blame.

Any amount of research confirms what the medicos call “the social gradient” – the well-off tend to be in much better health than those near the bottom. They’re less likely to be overweight (I must be an exception) and less likely to smoke.

The Mitchell Institute at Victoria University has just issued the second edition of its “health tracker by socio-economic status”. It finds that the 10 million Australians living in the 40 per cent of communities with lower and lowest socio-economic status have much higher rates of preventable cardio-vascular diseases, cancer, diabetes or chronic respiratory diseases than others in the population.

Why then should we be surprised to learn that, though Sydney’s outbreak of the Delta variant seems to have started in the better-off eastern suburbs, it soon migrated to the outer south west, where it finds a lot more business?

Last week the welfare peak body, the Australian Council of Social Service, issued a joint research report on Work, Income and Health Inequality, with academics at the University of NSW.

ACOSS boss Dr Cassandra Goldie says “the pandemic has exposed the stark inequalities that impact our health across the country. People on the lowest incomes, and with insecure work and housing, have been at greatest risk throughout the COVID crisis. Now, they are the same people who are at risk of missing out in the vaccine rollout”.

Then there’s the question of trust. Social trust works through social norms of behaviour, such as willingness to co-operate with strangers and willingness to follow government rules. As in other rich countries, our trust in governments has declined over the years. Last year it seemed to lift, as many of us believed we could trust our leaders – particularly the premiers – to save us from the pandemic.

Whether that confidence survives this year’s missteps we’ll have to see. But the economic historian Dr Tony Ward, of Melbourne University, reminds us of a significant finding in this year’s World Happiness Report: in general, the higher a country’s level of social trust, the lower its COVID-19 death rate.

Stay with me. An experiment by the American behavioural economist Alain Cohn and colleagues in Switzerland involved “losing” 17,000 wallets in 355 cities across 40 countries and seeing how many of them were returned to their supposed owners.

The rate of wallet return was about 80 per cent in the Scandinavian countries and New Zealand, just under 70 per cent in Australia, less than 60 per cent in the US and less than 30 per cent in Mexico.

Ward did his own study and found that two-thirds of the difference between countries could be explained by their degree of inequality of income. The greater the inequality, the less trust. When he added survey data on people’s perceptions of corruption, his apparent ability to explain the differences in trust rose from 68 per cent to 82 per cent.

Premier Gladys Berejiklian and her minions tell us the virus is raging in certain “LGAs of concern” because people aren’t doing as they’ve been asked. Maybe their lack of co-operation reflects a lack of trust in the benevolence of those higher up the income ladder. Inequality doesn’t come problem-free.

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Afterpay tells us we're suckers for the illusion of 'free'

There’s more to be learnt - sorry, there are more “learnings” – from the phenomenal success of Aussie “fintech” start-up Afterpay before it drifts off into corporate history. Learnings about human nature, public policy and what switched-on economists call “market design”.

Economists need to do more thinking about the way markets are – and should be – designed. The sub-discipline of market design recognises that, increasingly in the real world – especially the digital world – markets don’t work in the simple, transparent, what-you-pay-is-what-you-get way assumed by economics textbooks.

This means there’s more scope for “market failure” – market forces not delivering the benefits that economic theory promises they will.

Afterpay’s first “learning” is that, far from being “rational” – carefully calculating – consumers (and taxpayers) are hugely attracted by the illusion that something is free. Afterpay’s success seems explained by Millennials being greatly attracted by its promise to let them BNPL - buy now, pay later - without charging any interest.

It seems young people are turning away from credit cards and their very high interest rates in favour of BNPL. When you think about it, however, you see there isn’t much difference between a credit card and an Afterpay BNPL interest-free loan.

A standard credit card is also an interest-free BNPL loan provided you pay it off at the end of the month, in full and on the dot. Fail to manage that, however, and you soon see how high credit card interest rates are.

(Warning to all lawyers and judges: apparently, your legal learning robs you of the ability to understand the argument that follows. To a lawyer, any payment to a lender can’t be a payment of interest unless it’s wearing a label that says “interest” and is expressed as a percentage of the amount lent. You’d all make good Millennials.)

With an Afterpay BNPL loan, it’s only interest-free if you make four equal fortnightly repayments on time. If you’re late with a repayment, you’re charged a $10 late fee. And if you’re more than a week late you’re charged another $7.

The usurious nature of these charges is disguised by their small absolute size (but the amount borrowed is also pretty small) and by our practice of expressing interest rates on an annual basis (this loan is only for eight weeks, not 52).

But that’s not all. As Milton Friedman didn’t win his Nobel prize for discovering, there’s no such thing as a free lunch. Even if the borrower using either a credit card or BNPL manages to repay their loan without incurring any penalty, the lender still has to receive the equivalent of an interest payment to make the transaction worth funding.

In the case of both credit cards and Afterpay loans, this is achieved by a “merchant fee” paid by the retailer that made the sale. The fee is a percentage of the amount lent although, in the case of Afterpay, it’s a huge 4 to 6 per cent plus a flat 30c. (My guess is the 30c is there to fool lawyers into thinking the fee couldn’t possibly be payment of interest).

Whatever the reason, Afterpay has managed to convince the lawyers that, since BNPL obviously has nothing to do with borrowing and lending, it cannot be subject to the Credit Act, meaning Afterpay is not subject to the “responsible lending obligation” and so escapes the expensive obligation to do credit checks and verify the borrower’s ability to repay the debt. (We’re assured, however, that Afterpay and its many imitators are subjecting themselves to a voluntary code of conduct.)

This raises another “learning” right there. Almost invariably, the many market disrupters produced by the digital revolution – including Uber and Airbnb – amount to the combination of a genuine, productivity-enhancing innovation (something every economist wants to encourage) and a trumped-up claim that, because we’re so new and different, none of the regulation that shackles the existing industry applies to us.

“Their workers are employees, ours aren’t. The firms we’re disrupting have to provide employee super contributions, annual and sick leave, and workers compensation insurance, as well as comply with health and safety requirements, but we don’t.”

This, of course, is why we’re developing a two-class workforce, where those unfortunate enough to be able to find work only in the “gig economy” have badly paid, precarious employment with bad conditions and few rights.

The thought that this regression to feudal conditions for some should be allowed to persist in an economy as rich as ours is utterly repugnant. And to respond to it by introducing a universal basic income is an admission of defeat.

But before we leave Afterpay, there’s another learning. Using merchant fees to hide the interest cost of BNPL schemes, whether credit cards or Afterpay-style, involves an arrangement that’s both inefficient and unfair. It encourages retailers to recover the effective interest cost by raising their prices to all their customers, thus obliging those who pay cash or with a debit card to subsidise those who choose to BNPL.

Afterpay prohibits retailers from recouping the cost by asking those who choose BNPL to pay a surcharge. Just as Visa and Mastercard used to prohibit retailers from imposing a surcharge on those who choose to pay by credit card.

For obvious reasons, the promoters of supposedly interest-free loans want the true cost of this free lunch to remain hidden. The Reserve Bank – which has oversight of payment system regulation – laboured for years to get the prohibition on credit-card surcharges outlawed, and finally succeeded.

These days, credit-card surcharges have become common. My guess is that these surcharges, not just the advent of Afterpay and its imitators, help explain the big shift from credit to debit cards. This is just what the Reserve wanted to see.

But it’s utterly inconsistent for the authorities to stop the banks from banning surcharges while allowing Afterpay to ban them. Maybe they’re applying some kind of infant-industry argument. Let them get established, then rope them into the regulatory fold.

Final learning: look around and you find our human susceptibility to the illusion of “free” in lots of places. Starting close to home, free-to-air television and – until Google and Facebook stole our business model – almost-free newspapers and websites were so much a part of the furniture that it was easy to forget that the cost of all the advertising they carried was buried in the cost of most of the things we buy.

The internet still carries a host of free sites with interesting and useful information, even if the legacy newspaper companies have finally moved to making most of their money via subscriptions.

Then there are Google and Facebook, for whom the market-design people have invented a new bit of jargon. They are “multi-sided platforms” whose ostensibly free services are paid for by selling to advertisers the myriad information the platforms have gathered about the preferences, actions and locality of their users.

But our love of the supposedly free – our preference for having the true cost of things hidden from our sight – applies just as much to us as taxpayers. It took the Liberals a long time to realise how much voters loved Medicare, and didn’t want it fiddled with. Why the great love? Bulk billing. The way it makes visits to GPs and hospitals appear free.

Despite all their speeches on the evils of higher taxes, the Libs (like Labor) have never needed to be told of the one tax increase we don’t mind because we don’t see it: bracket creep. When it comes to kidding ourselves, we’re past masters.

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How Morrison can claim emissions are falling when they aren’t really

Other world leaders have treated this week’s report by the UN Intergovernmental Panel on Climate Change as a “wake-up call,” whereas our leader, Scott Morrison, has mumbled something about how we’re on track to “meet and beat” our emissions reduction target, and gone back to sleep.

The report finds that whereas the world’s increase in average temperatures since the start of the industrial era is 1.1 degrees, our average land temperature has risen by 1.4 degrees over the past century – which does much to confirm the impression most of us have that droughts, floods, bushfires, heatwaves and cyclones are now bigger and more frequent than they used to be.

Climate change isn’t coming, it’s arrived.

At the UN climate change meeting in Paris in 2015, countries agreed to each reduce their emissions of greenhouse gases sufficiently to limit the rise in average temperatures to 2 degrees, and preferably no more than 1.5.

The report’s wake-up call was its revised prediction that warming of 1.5 degrees could be reached by the early 2030s, much sooner than formerly expected. So we’ve got even less time than we thought.

At the Paris meeting, each country announced its “nationally determined contribution” to the reduction in global emissions. It was agreed that each country would review and increase its contribution every five years.

The first round of increases will be announced at the next “conference of the parties” in Glasgow in November. In preparation for the conference, almost all of the world’s 20 biggest emitters – including the G7 countries, China and us – have committed to reach net zero emissions by 2050.

But 2050 is a long way off – perhaps too far off. What matters more is the increases countries make in their contribution targets in Glasgow. At their summit meeting in Cornwall in June, the G7 members agreed to increase their reduction targets to between 40 and 63 per cent over the same period.

It’s possible Morrison will decide to accept the net zero emissions target by 2050, and possible he’ll go to Glasgow promising an improvement on our original Paris contribution of a 26 to 28 per cent reduction on 2005 emission levels by 2030.

This week, however, he was promising nothing. Why not? Because we’re already set to “meet and beat” our original target. Indeed, the most recent figures show our emissions are already down 20 per cent on 2005, he said.

And, as he’s told us many times, we’re world-beaters when it comes to moving to renewable, wind and solar energy.

Now, you’ve probably heard there’s something sus about these wonderful don’t-you-worry-about-that figures Morrison and his ministers keep tossing around. The people who know and care about climate change say our emissions are getting worse, not better.

The doubters are right. But we’re indebted to the Australia Institute think tank for producing a careful report spelling out how the government’s figures are able to be so misleading. The Australian National University’s noted emissions analyst, Hugh Saddler, tests Morrison’s claims that, when it comes to reducing fossil fuels use and transitioning to renewable energy sources, we’re at the front of the pack.

Saddler compares our performance with 22 other decent-sized members of the Organisation for Economic Co-operation and Development, plus Russia, on a number of key indicators of energy transition.

Examining our performance relative to the others between 2005 and 2019, Saddler found that we started at the back of the pack in 2005, and either maintained that position or had slipped even further by 2019 on all the indicators.

Australia remains among the highest emitters on a per-person basis, and on the basis of emissions per dollar of gross domestic product. On those indicators where our performance has improved over the period, the others have improved just as much as we have, if not more.

The “emissions intensity” of our energy system – that is, emissions per unit of energy consumed – is the highest, except for Poland. Why? Because both countries were, and still are, heavily reliant on coal for generating electricity.

Despite all Morrison’s boasting about how much we’re spending on wind and solar power, the others are also spending more. Our share of electricity generated from renewables has slipped back relative to the others.

But here’s the killer punch: we were one of only three countries out of the 24 whose emissions from energy use actually increased between 2005 and 2019. By 18 million tonnes of carbon dioxide equivalent a year, according to Saddler.

How can this possibly be reconciled with Morrison’s claim that our emissions have fallen by 20 per cent? It’s simple when you know. Saddler is talking about emissions from energy use, whereas Morrison is also including emissions from what the UN calls LULUCF – land use, land use change and forestry. In short, land clearing and logging.

This source of emissions has been included in the official calculations since Australia insisted on it at the Kyoto conference in 1997. And be clear on this: so it should be. I have no patience with greenies who think taking account of what’s happening to “carbon sinks” is somehow immoral. Tell that to the people who worry about the deforestation of the Amazon.

No, the point is not that land clearing should be ignored, but that we wanted it counted solely because we knew it would make our figures look a lot better than they really were. Why in 2015 did we want to set 2005 as the starting point for our promised cut in emissions? Because we already knew the cessation of land clearing in Queensland would make our performance look good even if we didn’t do anything much to reduce our use of coal and gas.

Trouble is, this long-passed, once-only improvement in land use does nothing to transform our energy use away from fossil fuels and towards total reliance on renewables. It thus does nothing to get us to net zero emissions.

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