Printing money to fund the deficit ain't the free lunch it seems

The new Treasurer, Dr Jim Chalmers, is saying a lot about the trillion-dollar debt he’s just inherited. He’s saying less about the tension between the new government’s plan to “invest” in improving the economy and all the pressure he’ll be under from mainstream economists to reduce the budget deficit and so reduce what Labor will be adding to that debt.

But whenever I write about debt and deficit, I know to expect puzzled or angry pushback from people who’ve read US Professor Stephanie Kelton’s bestseller, The Deficit Myth, or studied “modern monetary theory” (MMT) at university.

Why all this fuss about budget deficits? Who said the shortfall between what a government spends and what it raises in taxes must be covered by borrowing from the public? That’s just a rule someone made up.

Surely the government can avoid ticking up all that debt – with all the interest payments on it – simply by telling the central bank to “create” – some still say “print” – the money the government needs.

After all, all currencies are “fiat” currencies. When a government prints a $50 note, it becomes “legal tender” worth $50 merely because the government says it is. By government decree or fiat.

So why all the fuss about debt and deficit? Just create all the extra money the government needs with the stroke of the central bank’s computer program.

There’s a lot of truth in what the MMT people say. But if you think it all sounds a bit too good to be true, it is. So what’s the problem?

The “monetarists” of the 1970s taught that every time the government adds to the supply of money in circulation it adds to inflation. Not true. We value money because of what we can buy with it. Economists say what you’re buying is “command over real resources” – that is, raw materials, physical capital equipment and labour, often embodied in goods and services, or physical assets, including buildings and land.

Inflation is caused when the demand for real (that is, tangible) resources runs ahead of the supply of real resources, thereby causing prices to rise.

So, even though people spending the money you’ve created will add to the demand for real resources, this won’t cause inflation provided you do it when demand is weak. Only when you reach the point where demand catches up and overtakes supply will you have a problem with inflation.

That’s the purely pragmatic reason most economists disapprove of MMT. Once politicians had the idea they could keep spending without worrying about debt and deficit, how would you get them to stop adding to inflation by continuing to create money rather switching back to borrowing and having to pay interest?

How would you get them to do what Chalmers is doing as we speak: looking at all the spending plans of his Liberal predecessors that aren’t sensible and stopping them, so as to make room for Labor’s own spending plans?

Even so, as the econocrats would prefer me not to point out, the MMT brigade has had a qualified win. As part of the Reserve Bank’s resort to “unconventional” monetary policy during the pandemic – aka “quantitative easing” – it has bought more than $350 billion-worth of second-hand government bonds.

Bonds it paid for merely by crediting the “exchange-settlement accounts” that each of the banks it bought the bonds from has with the central bank.

So indirectly, the Reserve has done what the MMT people say it should have done: covered about $350 billion of budget deficits by creating money.

This means $350 billion of the government’s $1 trillion debt – and the related interest payments - is owed to the Reserve Bank, which just happens to be owned by the government. Roughly a third of the government’s debt is owed to, and must eventually be repaid to, itself.

So, the government’s liability is cancelled out by its subsidiary’s asset. That’s what I wrote a few weeks’ ago, and it’s true. But, as some fossilised central banker explained to me, it’s not the whole truth.

When you trace through all the double-entry bookkeeping, you see that the created money the Reserve paid into the banks’ exchange-settlement accounts in return for the bonds it bought is still sitting there. It’s still a liability on the Reserve’s balance sheet, and an asset on the banks’ balance sheets.

That money is part of what monetary economists call “base money”. Base money consists of all the “currency” – notes and coins – issued by the central bank, plus all the money the banks are holding in their exchange-settlement accounts at the central bank.

And the trick to base money is that its quantity can be changed only by a transaction with either the government or the central bank on the other end of it. That is, nothing anything any person or business or even a bank can do of their own volition can change the quantity of base money.

It’s true that bank A and bank B can do a deal that reduces the balance of bank A’s account – but only by increasing bank B’s balance by the same amount. That is, the banks can move base money around between themselves, but they can’t change the quantity of base money held by the banks as a whole.

OK, but why is this a problem? Because the banks have money they own stuck in bank accounts with the central bank, on which it pays little or no interest. They’d like to lend it to someone else at a much higher interest rate.

So they’re tempted to enter highly contrived, highly risky arbitrage arrangements which involve borrowing short-term and lending long-term. The Yanks call this “picking up dimes in front of a steamroller”.

It’s fine until there’s a financial crisis, which brings down banks and does huge damage to the rest of the economy, as we saw with the global financial crisis of 2008. Yet another case of there being no free lunches.

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Replacing the misbehaving ScoMo is an easy act for Albo to follow

It is a truth (almost) universally acknowledged by Labor politicians that it’s near impossible to reform from opposition. Be too ambitious, make yourself too big a target, and the government will happily use the many advantages of incumbency to shoot you down.

That’s because all reforms have opponents, and most create losers as well as winners. That’s why, after being reminded of this truth at the 2019 election, Labor made itself as small a target as possible. Part of this was for Anthony Albanese to neutralise most of Scott Morrison’s vote-buying promises by matching them.

Back then, Morrison convinced himself that – apart from having God on his side – his miraculous win was owed to his cunning strategy of painting Labor as the party of tax-and-spend, and the Liberals as the party of lower taxes. He tried repeating the strategy this time.

The first part of his mantra was true enough. The second was bulldust. As independent economist Saul Eslake has demonstrated, in the highest-taxing stakes, the just-departed government runs second only to the Howard government.

Find that hard to believe? You’re forgetting the invisible magic of bracket creep. The loophole in Morrison’s promise not to raise taxes – which Albanese matched – is that it doesn’t include bracket creep. And now that inflation’s back, bracket creep proceeds apace.

Many of the reforms we need – fixing aged care, reversing the squeeze on universities and TAFE, making homeownership affordable, exploiting our chance to become a renewables superpower – would cost big bucks and require greater and changed taxation.

But Albanese’s problem is not just that he’s promised not to increase taxes while making a huge and blatantly unfair cut in income tax in two years’ time, or even that he’s inherited a big budget deficit and huge debt overhang.

That much you see from the budget papers. What you can’t see is the extent to which the Morrison government has been holding back the tide of higher spending by cutting public service jobs, increasing waiting times, cutting NDIS packages and finding excuses to suspend people’s dole payments.

This dam had to burst after the election. And it will do so at just the time when the econocrats are telling Labor the budget deficit must go down, not up.

What was it Paul Keating used to say about excrement sandwiches? Come on down, Albo.

But all is not lost. For a start, on expensive and controversial reforms, Albanese should follow the aforementioned Eslake’s advice and copy John Howard. He got elected in 1996 with a promise to “never, ever” introduce a goods and services tax. So he made an honourable escape by having such a tax fully developed for presentation at the next election.

It was approved – by a whisker. As Eslake reminds us, not since 1931 has any first-term federal government failed to secure a second term.

“Labor needs in its first term to lay the groundwork for a more expansive mandate for its second term,” Eslake recommends.

Next, Labor does have a mandate – both direct and indirect, via the higher votes for the Greens and teal independents – to proceed with climate action, an anti-corruption commission “with teeth”, gender equality, and commitment to the Uluru Statement from the Heart “in full”.

Except for climate action, none of these historic reforms will greatly trouble the budget accountants.

However, as Professor Mark Kenny, of the Australian National University (but formerly of this parish), has helped us see, this election was about something deeper: “The urgent need to rescue longstanding governing norms around transparency, accountability, ministerial standards, trust and honesty and, of course, the viability of the public service.”

Morrison’s approach, he says, was “divide and dither”. “Accountable government, national unity, evidence-based policy, and democratic accountability [whether voters give his performance a tick or a cross] are all on the ballot at this election.”

Let’s get personal. The biggest reason Albanese is now PM is that he’s not Scott Morrison. The biggest policy question in this election, the one almost everyone in the great majority who didn’t vote for the Coalition wholeheartedly endorsed, was: “would you like to see no more of Scotty from marketing?”

It’s simple. The surest way for Albanese to ensure his re-election is to be a better, more likeable PM than that other one.

Just be more truthful, more respectful, more humble, more answerable, more willing to admit your mistakes, more inclusive, more even-handed, more charitable towards the needy, more willing to answer the question, and more protective of Australia’s reputation abroad.

Be less prevaricating, less divisive, less bulldozer-like, less willing to help mates and punish enemies, and less unable to let that five-letter S-word pass your lips unqualified.

I think Albanese’s already got that message. “I want to bring people together and I want to change the way that politics is conducted in this country,” he’s said. Australians have “conflict fatigue”.

Being a saintly prime minister won’t be easy. But think of it this way: conduct-wise, being ScoMo’s successor won’t be a hard act to follow.

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Who's in government matters, but pollies have far from total control

According to Scott Morrison’s last-minute appeal, in deciding our vote we should have considered nothing but the economy and stuck with the Coalition, the only team to be trusted with financial matters. But we spurned his advice and put Labor in charge. Now what happens?

Will the economy be better or worse under Anthony Albanese and a new treasurer, Jim Chalmers?

Short answer: whether economic conditions get better or worse in the next three years will be changed only to an extent by a new government. Things will be different, but not hugely so.

That’s for four reasons. First, because, in our more globalised world, much of what happens is beyond the ability of any government to control. Second, because economies are like ocean liners: they take a long time to answer the helm.

Third, because in this small-target election, Labor’s stated policies weren’t greatly different from the Liberals’. And finally, the elected government shares the management of the economy with the independent Reserve Bank, which made its intention to continue raising interest rates crystal clear earlier this month.

In their response to the pandemic, Morrison and his erstwhile treasurer, Josh Frydenberg, stuck pretty closely to Treasury advice about the budget’s role. And I’ll be surprised to see Labor doing much freelancing.

But aren’t the Libs much better at economic management than Labor? That’s the stereotype deeply ingrained in the thinking of many voters – which Morrison was seeking to evoke in his last-minute appeal.

Trouble is, hard evidence to support this pre-judgment is hard to find. In a recent extensive review of the figures by the independent economist Saul Eslake, he could find no strong support for the idea that one side was clearly better than the other.

Why not? For the four reasons I’ve just listed.

So how is Labor likely to do? Not as well as the new government’s supporters hope, but not as badly as its opponents predicted. At this early stage, however, when we’re so fully conscious of the failings of the last lot, we’re entitled to hope for some improvement.

One we can hope for is that the new government won’t be playing favourites and enemies like Morrison did.

Whatever does happen to the economy in the next few years, one thing we can be sure of is that the Libs will claim to have handed over an economy in tip-top condition. Morrison and Frydenberg spent the entire campaign telling us how “strong” the economy is.

It is in some respects, but not in others. It’s certainly true that the jobs market is in better shape than it’s been in decades. At 3.9 per cent, the unemployment rate is at its lowest in 48 years and underemployment is its lowest in 14 years. The proportion of working-age people with jobs has never been higher.

You’d expect this to mean wages are also growing strongly, but not a bit of it. Wages have struggled to keep up with prices for the past decade and, with the recent surge in prices, have fallen well behind.

Part of the reason is that, thanks to weak business investment in better equipment, there’s been little improvement in the productivity of labour. Living standards have hardly improved in since before the Coalition took the reins in 2013.

It’s weak wage growth that does most to explain why the high cost of living seemed the biggest issue in this election. And it’s the cost of living that helps explain why voters turned on the self-proclaimed great economic managers.

Business profits are doing fine, but the Liberals have failed to deliver ordinary working families their fair share of the lolly – and allowed many of their jobs to become less secure. And that’s before you get to the huge budget deficits the government itself foresaw extending further than the eye could see.

There’s one issue it’s reasonable to expect Labor to care more about and do more to fix: making wages grow faster. Can any government do much about wages? Of course. They can start by urging the Fair Work Commission to lift award wages in line with prices. And give their own employees a decent pay rise after years of wages being held back.

A staunch Liberal mate thinks this was a good election for his side to lose. He thinks the world economy’s likely to weaken and this, combined with our problem using higher interest rates to control inflation, might see us fall back into recession.

I’m not so pessimistic.

There may be some rocky times ahead as the world copes with its various problems. But the Reserve Bank knows if it raises interest rates so high they capsize the economy, all fingers will be pointing to it, not to Albanese and Chalmers.

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Election: a win for the punters against the party professionals

Listening to Anthony Albanese’s victory speech on Saturday night – promising to be a better, more inclusive leader than his predecessor, to help the needy as well as the party heartland, to work hard fixing as many of our problems as humanly possible – my inner accountant came out. Yes, but how will you pay for it all?

If ever there was a case of oppositions not winning elections but governments losing them, this is it. Much more than usually, this election result was voters rejecting not so much the Liberal Party and its policies, but the party’s leader and his divisive, often disrespectful way of conducting himself and his preoccupation with clinging to a fossil-mining past rather than striving for a future as a renewable energy super-power.

What motivated all those people – particularly women – in the most prosperous parts of Sydney and Melbourne to break the habit of a lifetime and vote for a teal independent rather than the Liberal member they had no special gripe against?

It was their overwhelming desire to see and hear no more from the most un-Christlike Christian they could imagine. A bulldozer, indeed. It’s significant that the people they voted for were well-educated, successful businesswomen. Female equality was also a big motivation for the Liberal revolt.

So too, Scott Morrison’s puzzling resistance to the obvious need for a federal anti-corruption commission “with teeth”. If he had nothing to fear, what was his problem?

But it wasn’t just the teals. What about the resurgence in the Greens’ vote, and all the Liberal and Labor voters in Brisbane who switched to the Greens? It’s obvious from the two separate revolts against both major parties that the need for more urgent action against climate change was the election’s single biggest issue.

This despite the majors’ desire to avoid talking about climate change – which the media meekly accepted. It’s significant that both the Greens and the teals were promising much earlier and bigger reductions in emissions. Albanese ignores this message at his peril.

The one issue the majors were happy to debate was the cost of living. So, with the media’s willing acceptance, this became the central issue of the campaign. The great cost-of-living election, with the Reserve Bank making a guest appearance.

Really? Where’s the evidence of that being a key influence on the result? Well, I guess it’s the main reason Labor – the party promising to increase wages – did take a number of seats away from the Libs, in the way the two-party textbook says elections should work.

But we’ve yet to see whether Labor won enough of those seats to form a majority government.

The notion that minority government is a recipe for instability bordering on chaos is a self-serving lie spread by the two majors.

Look at the record – federal and state – and you find that the deals the majors have done to guarantee “confidence and supply” not only achieve stability, they allow the crossbenchers to achieve valuable reforms – often to do with transparency and accountability – that neither of the majors fancies.

With the Gillard minority government, the main gain was a tax on carbon – which, had it survived the depredations of Tony Abbott, would have left us much better-placed today.

We seem to have moved to a non-praying prime minister, but if I were Albanese I’d be praying to be left in a position where I had to let the Greens or the teals impose on me a much more adequate policy on climate change – consistent with the electorate’s now-revealed preference.

This election is no ringing endorsement of Labor, Albo and his small-target policies. The new government has won with an amazingly low primary vote. Timid Labor was not the nation’s first preference.

The election is a step-change in the public’s long-running move away from the two-party system. It was the voters’ message to the Lib-Lab duopoly: “Stuff you and your how-to-vote cards, I’m doing it my way.” If Labor thinks it’s just the Libs with a problem, it’s not thinking.

Albanese’s other problem is that his small-target strategy involved tying one hand behind his back. What he thought he had to do to win government is the opposite to what he now must do to prove himself worth re-electing.

He has inherited a big budget deficit and massive public debt, and will be under great pressure to get that deficit down.

How? He’s promised to deliver the Liberals’ hugely expensive and unfair tax cut in 2024, while promising no tax increases. By cutting spending on health, education, welfare and the NDIS? They’re the things he’s promised to spend more on.

You want to do something about unaffordable homeownership? That requires increasing the tax on home-owners and investors. Where’s Harry Houdini when you need him?

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Infrastructure spending has degenerated into wasteful vote buying

The capacity of our politicians to take a good economic policy idea and pervert it into a partisan waste of taxpayers’ money never ceases to appal.

Once I was a big supporter of greater spending on infrastructure projects, even when most of the cost had to be borrowed. That’s because well-chosen projects will add to the economy’s productivity – say, by reducing the time taken to get from A to B – and thus more than pay for themselves over time.

But for that, you have to be sure to pick only those projects that offer economic and social benefits well exceeding their costs. When a politician doesn’t bother with that, but picks projects just on winning votes, you can’t even be sure people in the chosen electorate will gain much benefit.

In this election campaign, the Morrison government’s promise to add transport infrastructure spending of $18 billion to our already high public debt in the hope of buying votes in key electorates, would not only involve wasting much money. It would also “crowd out” spending on more valuable things, such as education, aged care or research.

Of course, Labor plays the same game. In this election, however, it’s proposing to waste no more than $5 billion. (This is a big improvement on the 2019 election, when Labor wanted to spend $49 billion, against the Coalition’s $42 billion.)

It would be good to have some knowledgeable person keeping tabs on these huge sums. And fortunately, there is: Marion Terrill, of the Grattan Institute.

In her assessment of the two parties’ promises this time, she notes that the emphasis on winning votes in key marginal seats is quite unfair. Those of us not in marginal seats get little of the moolah. And some states get a lot more than others. The Coalition is offering nearly $900 per Queenslander, compared with about $500 a person in NSW and Victoria.

As for Labor, it’s offering close to $400 a person in Victoria, with Queenslanders next on about $200 each.

Total bribes are well down this time because billion-dollar projects are less prevalent, with the Coalition offering just five (in ascending cost, the Sydney-Newcastle rail upgrade, the Brisbane-Gold Coast rail upgrade, the Beveridge intermodal terminal in Victoria, the Beerwah-Maroochydore rail extension and the North-South Corridor in South Australia) and Labor offering just one (the Melbourne suburban rail loop).

Note, however, that none of these six projects has been assessed by Infrastructure Australia as nationally significant and worth building. Only one of them has actually failed the assessment (the cost of the Maroochydore rail extension was found to exceed its benefits), with the other five being proposed without completed assessments.

Terrill says it’s prudent to be stepping back from last election’s megaproject binge. For some years, the engineering construction industry has been warning about its limited capacity to deliver the existing pipeline of projects, let alone add to it. Even before the pandemic, employment in the sector had surged by half, and supply-chain disruptions had made it slower, more difficult and more expensive to find materials.

With the recent slowing in population growth, maintaining and upgrading existing assets should take priority over big new projects. But both parties have promised to spend more on new projects than upgrades. Pollies always prefer the flashier projects.

But while big projects are down, tiny projects are way up. Two-thirds of the Coalition’s promised spending is on projects costing $30 million or less, and nearly half of Labor’s. We’re talking commuter station car parks and roundabouts.

My guess is this is about spending less money overall on projects targeted towards many more key electorates. That is, it’s about greater vote-buying efficiency. Presumably, the voters in these seats find the projects attractive.

But that doesn’t make the money well-spent. Terrill reminds us these tiny, hyper-local projects violate a longstanding principle that the Feds stick to infrastructure of national significance, leaving the small stuff to state and local governments.

They know a lot more about what’s most needed where, meaning that when the feds blunder in with their vote-buyers, things often go amiss. Many commuter car parks promised at the last election had to be cancelled, Terrill says, because there were no feasible design options, feasible sites or because the rail station was being merged with another.

How were the young political staffers with their whiteboards in Canberra supposed to know that?

Terrill notes two further objections. First, “the quality of the projects promised in the heat of election campaigns is poor,” she says. The tiny projects are too small to be assessed by Infrastructure Australia and, as we’ve seen, the big ones get promised without completing proper assessment.

Second, she says, “government decisions should be made in the public interest, and those making the decisions should not have a private interest – including seeking political advantage with public funds”.

“A better deal for taxpayers would be for whichever party wins government on Saturday to halt this spending on small local infrastructure, and focus instead on nationally significant projects that have been properly assessed by Infrastructure Australia,” Terrill says.

In an earlier report, Terrill argued that the next government should strengthen the transport spending guardrails. It should “require a minister, before approving funding, to consider and publish Infrastructure Australia’s assessment of a project, including the business case, cost-benefit analysis, and ranking on national significance grounds”.

This would go a long way towards increasing the social and economic benefit from projects, while reducing their use to buy votes with taxpayers’ money.

And all that’s before you get to cost-overruns. Back in 2020, Terrill reported that the Inland Railway was originally costed at $4 billion, whereas the latest estimate was $10 billion. Melbourne’s North-East Link had gone from $6 billion to $16 billion. The Sydney Metro City & Southwest underground had gone from $11 billion to $16 billion. Incompetence or deliberate understatement?

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Modern politics goads us to be greedy, and forget the needy

Mark, a voter in the Melbourne electorate of Higgins, told the ABC’s Virginia Trioli this would be the last federal election he’d be alive to vote in. So he’d decided his vote should not be for him, but for the younger generation coming after him.

He wanted to cast his final vote for the party that best represented young people’s aspirations for their future. So he went to the local high school and got permission to talk to the senior students.

And which side did they pick? “It’s the Greens. And that’s the first and last time I’ll be voting for them,” he said.

It’s a sad commentary on modern politics that no mainstream politician would dare suggest we vote for them because they’d best advance the public interest. They know that we know their greatest interest is in advancing their own career so, to attract our votes, they offer bribes.

They’ve trained us to see elections as transactional, not aspirational. You want my vote? What are you offering? And is that better or worse than the other side’s offering?

That’s how, with climate change and so many other, lesser problems needing attention, we’re devoting most of this campaign to grappling with the great challenge of our age ... the cost of living. Really?

Now, I don’t blame people on low incomes with big commitments who really do struggle to get by for wanting to see what the two sides are offering that might make their lives easier.

But you don’t have to be struggling to tell yourself your life’s a struggle, and you wouldn’t mind voting for a pollie offering you a few more bangles and baubles.

I can’t be the only voter in the land whose comfortable lifestyle is not in any way threatened by the rising cost of living.

A reminder from Struggle Street would be timely. My co-religionists, the Salvos, release today a report on how their clients are faring, preparatory to knocking on your door the weekend after the election. (If you’re wondering, at present I hold the rank of backslider, but there’s still a lot of Salvo in me.)

The Salvos took a random sample of 10,000 of the people who had attended their emergency relief centres in the past 12 months. More than 1400 people responded to the request to complete an online questionnaire.

The survey showed that, after paying for housing costs, 93 per cent of respondents were living below the poverty line, with almost two-thirds needing to ask for financial help from family and friends.

The high proportion of these people’s meagre incomes devoted to rent is their biggest problem, leaving too little for food and all the rest.

Although some respondents would be working poor, most would be on government support payments, including the parenting payment and disability support payment. Among these people, 60 per cent say they can’t afford medical or dental treatment when they need it, and well over half say they’re going without some meals.

Dr Cassandra Goldie, head of the Australian Council of Social Service, reminds us that poverty isn’t an unfortunate but unavoidable fact of life, it’s a policy choice. We have a system of support payments that’s supposed to keep people out of poverty, but choose to set the payment level below the poverty line.

A recent national poll of 1000 adults commissioned by ACOSS and conducted by Ipsos has found that 76 per cent of respondents say they couldn’t live on $46 a day, the present rate of Jobseeker. Two-thirds agree the rate should be above the poverty line, which is $70 a day.

When the first lockdown in 2020 prompted the Morrison government to almost double the rate of Jobseeker, the payment rose above the poverty line. People couldn’t believe how much easier their lives had become, and requests for help from outfits like the Salvos fell away – although many overseas students and other holders of temporary visas needed feeding.

But Scott Morrison’s Christian charity lasted only six months. In the end, the biggest permanent increase he could afford was $6 a day. Need for help from the Salvos has returned. In this campaign, however, Morrison has been able to promise various new benefits to self-funded retirees who, by definition, are too well-off to qualify for the age pension.

When Anthony Albanese abandoned Labor’s promise from last election to review the level of unemployment benefits, he pointed to the big budget deficit he’d inherit. I can see his problem. If he were to spend more helping people living below the poverty line, how could he afford the $9000-a-year tax cut he (like Morrison) has promised me and my ilk in 2024? He’s saving up.

Last word to my superior officer, the Salvos’ Major Bruce Harmer: “We’re calling on the next elected federal government to focus on the most vulnerable in society. Being able to meet basic living expenses should be the norm for all in an advanced economy like Australia, and not something we are still discussing in 2022.” Amen to that.

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Inflation: workers being unreasonable, or bosses on the make?

When you think about it clearly, the case for minimum award wages to be raised by 5.1 per cent is open-and-shut. So is the case for all workers to get the same. This wouldn’t stop the rate of inflation from falling back towards the Reserve Bank’s 2 to 3 per cent target zone.

But if, as seems likely, the nation’s employers contrive to ensure that this opportunity is used to continue and deepen the existing fall in real wages, the nation’s businesses will have shot themselves in the foot.

What, in their short-sightedness, they fondly imagined was a chance to increase their profits, would backfire as this blow to households’ chief source of income, crimped those households’ ability to increase or even maintain their spending on all the things businesses want to sell them.

The recovery from the “coronacession” would falter as households’ pool of savings left from the lockdowns was quickly used up, and their declining confidence in the future sapped their willingness to run down their savings any further.

Should the economy slow or even contract, unemployment could rise and the hoped-for gain in profits would be lost. Cheating your customers ain’t a smart business plan.

Such short-sighted thinking by businesses involves a “fallacy of composition” common in macro-economics: what seems “rational” behaviour by an individual firm doesn’t make sense for firms as a whole. It’s a form of “free-riding”: it won’t matter if I screw my workers because all the other businesses won’t screw theirs.

But back to wages. If all workers got a 5.1 per cent pay rise to compensate them for the 5.1 per cent rise in consumer prices over the year to March, thus preserving their wage’s purchasing power, surely that means the inflation rate would stay at 5.1 per cent?

Firms would have to raise their prices by 5.1 per cent. But many small businesses wouldn’t be able to afford such a huge pay rise and would give up, putting all their workers out of a job.

Is that what you think? It’s certainly what the employer-group spruikers want you to think. But it’s nonsense. Hidden within it is a mad assumption, that wages are the only cost a business faces.

Unless all those other costs have also risen by 5.1 per cent, the business can pass on to its customers all the extra wage cost with a price rise of much less than 5.1 per cent.

How much less? That’s a question any competent economist could give you a reasonably accurate answer to by looking up the Australian Bureau of Statistics’ most recent (for 2018-19) “input-output” tables and doing a little arithmetic.

The tables divide the economy into 115 industries, showing the value of all the many inputs of raw materials, machinery, labour, rent and other overheads to the process by which the industry produces its output of goods or services.

Any competent economist (which doesn’t include me, I’m just a journo) could do this, but only two economists from the Australia Institute, Matt Saunders and Dr Richard Denniss, have bothered, in a paper forthcoming this week, Wage price spiral or price wage spiral?

The official tables show that the proportion of total business costs accounted for by labour costs (that is, not just wages, but also “on-costs” such as employer super contributions and workers comp insurance) varies greatly between industries, ranging from less than 3 per cent in petroleum refining to almost 71 per cent in aged care.

But this “labour/cost ratio” averages just 25.3 per cent across all 115 industries.

Now, let’s assume all workers in all industries received a 5 per cent pay rise, and all businesses chose to pass all the extra cost through to prices. By how much would prices rise overall? By 1.27 per cent.

That’s going to keep inflation soaring? It’s well below the Reserve’s 2 to 3 per cent target range.

Of course, that’s just what economists call “the first-round effect”. What about when all a firm’s suppliers put their prices up to cover their wage rises? The “second-round effect” takes the overall rise in prices from 1.27 per cent to 1.85 per cent – still below the target.

Do you remember when the ABC quoted some spruiker saying the cost of a cup of coffee in a cafe could rise to $7? The authors use the tables to show that passing on a 5 per cent pay rise could increase the retail price of a $4-cup by 9 cents.

(Such people are always telling us a crop failure in South America has doubled or trebled the price of coffee beans. It’s the same trick: they never mention that the cost of beans is the least part of the price of a coffee. The biggest cost is often renting the cafe.)

Now get this. That 1.85 per cent rise in prices probably overstates the effect of a universal 5 per cent wage rise, for three reasons.

First, because it assumes zero improvement in the productivity of labour. It’s not great at present, but it’s not non-existent. Second, it assumes firms don’t respond to higher costs by shifting to cheaper substitutes.

And third, because six of the 10 “industries” with the highest labour cost pass-through are either government departments (which don’t actually charge a price that shows up in the consumer price index) or are heavily subsidised by government. Effect on the budget isn’t the same as effect on inflation.

Note that whereas the Fair Work Commission has the ability simply to order a 5 per cent rise in the many minimum award rates covering the lowest-paid quarter of the workforce, should it choose to, the public and private sector employers of the remaining three-quarters of workers are unlikely to be anything like that generous.

That’s a fourth reason the effect of wage rises is likely to be (a lot) less than the authors’ simple calculation of a 1.85 per cent rise in retail prices.

But don’t get the idea wages are the only reason consumer prices rise. Wage rises would explain little of the 5.1 per cent rise in consumer prices over the year to March.

The great bulk of the rise is explained by businesses passing on to retail customers the higher prices of imported goods and services caused the pandemic’s various supply disruptions and the Ukraine war’s effect on energy and food prices.

But some part of that 5.1 per cent rise in prices is explained by businesses deciding now would be a good time to raise their prices and fatten their profit margins. This may not be a big factor so far, but I won’t be surprised if it’s a much bigger one this quarter and in future.

For months the media have been telling us how much a problem inflation has become, with a lot worse to come. Top business leaders and industry lobbyists have used naive reporters to, first, send their competitors a message that “we’re planning big prices rises so why don’t you do the same” and, second, soften up their customers. “Prices are rising everywhere – don’t pick on me.”

It’s quite possible we’ll have trouble getting inflation back into the target range. If so, it won’t be caused by big pay rises – but it’s a safe bet people will be using a compliant media to blame it on greedy workers.

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Cutting real wages will help inflation, but weaken the economy

At last, as the election campaign reaches the final stretch, we’ve found something worth debating. Anthony Albanese has found his spine and supported a big rise in award wages, while Scott Morrison says a decent rise for the masses is a terrible idea that would damage the economy.

First the politics, then the economics. My guess is history will judge this to be the misstep that did most to cost Morrison the election. Successful Liberal leaders – John Howard, for instance – know never to be caught within cooee of a sign saying “wages should be lowered”. It’s not the way to woo outer-suburbs battlers to the Liberal cause.

That Morrison should defy this precedent in a campaign where the cost of living has become by far the biggest issue is all the more surprising.

Between them, the two contenders have revived and highlighted the oldest stereotype in Australia’s two-party politics: the Labor Party is - surprise, surprise – the party of ordinary workers, and will always champion their interests, whereas the Liberals are the party of business, and will always champion the interests of business.

It’s because the Libs are seen as the bosses’ party that they’re instinctively regarded as better at managing the budget and the economy – a mindset Morrison is desperately seeking to exploit in “these uncertain times”.

But the other side of the penny is that Labor, the party of the workers, is the party that cares, and will spend more on providing government services. Which party’s best at industrial relations and wages? One guess.

But how do the minimum wage arrangements work? And what are the broader economic implications of a rise high enough to cover the 5.1 per cent rise in consumer prices over the year to March - or not high enough, so that wages fall in “real terms”?

The Fair Work Commission conducts an annual wage review to determine the increase in the national minimum wage on July 1. Last year’s increase of 2.5 per cent applied to the 2 per cent of employees on the national minimum rate, but also the 23 per cent of employees whose wage is set by one of the various minimum rates for workers in different job classifications set out in each of the more than 100 industrial awards established by the commission.

The national minimum wage rate is about $20 an hour, or about $40,000 a year for a full-time worker. About 2.7 million workers have their wage set in this way.

A 5 per cent increase in the national minimum wage would be worth about $1 an hour or about $2000 a year. Note, however, that many of those in more skilled award classifications would be earning much more than that.

The rises the industrial parties ask for in hearings before the commission are always “ambit claims”. The Australian Council of Trade Unions wants a rise of 5.5 per cent.

On the employer side, the Australian Industry Group says the most its member businesses could possibly afford is 2.5 per cent. The Australian Chamber of Commerce and Industry says the most it could run to is 3 per cent.

Morrison has implied it would be quite improper for a federal Labor government to seek to influence the decision of the independent commission. But the fact is federal and state governments routinely make submissions to provide information about the state of the economy and indicate how generous or tight-fisted they think the commission should be – though they rarely suggest a specific figure.

The commission will give due consideration to a government’s submission but, rest assured, it will do as it sees fit, usually awarding an increase somewhere between the employers’ lowball and the unions’ highball.

My guess is this year’s decision will be a lot higher than last year’s 2.5 per cent, but not nearly as high as 5.5 per cent.

That’s particularly because the commission can be expected to allow for the 0.5 percentage-point increase in employers’ compulsory contributions to their workers’ superannuation accounts this July. The unions would love to have their cake and eat it, but I doubt they’ll be allowed to.

Albanese says, “the idea that people who are doing it really tough at the moment should have a further cut in their cost of living is, in my view, simply untenable”.

Morrison claims a minimum-wage increase sufficient to stop wages falling behind the rise in consumer prices would be “reckless and dangerous”.

The Ai Group warns that “an excessive minimum wage increase would fuel inflation and lead to higher interest rates . . . than would otherwise be the case”. It would be detrimental to economic growth and job creation.

The chamber of commerce says “any increase of 5 per cent or more would inflict further pain on small business, and the millions of jobs they sustain and create. Small business cannot afford it”.

So, what do I think? I think it’s easy to exaggerate the economic cost of giving our lowest-paid workers a decent pay rise. Small business always cries poor and warns jobs will be lost. But there’s little empirical evidence that higher wages lead to job losses.

It’s true that giving a quarter of our workers little or no compensation for the jump in prices caused by pandemic supply disruptions and the Ukraine war would be the quickest and easiest way to get inflation back down to the Reserve Bank’s 2 to 3 per cent target range.

But it would also be hugely unfair to load that burden onto our lowest paid workers, while business profits escaped untouched. The Reserve will just have to be more patient if it doesn’t want to crunch the economy with big rate rises.

And here’s the bit the business lobby groups seem too short-sighted to see. The more we cut the real incomes of our businesses’ customers, the less businesses will be able to sell to them, and the more the economy will be in anything but the “strong” condition Morrison keeps claiming it’s in.

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In this election, one critical issue stands above all others

In this campaign we face a bewildering array of problems needing attention: the punishing cost of homes, the appalling treatment of people in aged care, the high cost of childcare, the neglect of every level of our education system, the continuing destruction of our natural environment and the pressure on our hospitals, not to mention the cost of living.

But there’s one problem that’s the most threatening to life, livelihood and lifestyle, the most certain to get a lot worse, the most imminent and the most urgent.

It’s not the cost of living, nor the risk of war with the Solomons (I joke), nor even the dubious behaviour of Scott Morrison and his ministers and their refusal to establish a genuine anti-corruption commission.

I’ll give you a clue: as I write, my fifth grandchild is on the way. I find it hard to believe anyone could be so self-centred and short-sighted as to think any problem could be more important or more pressing than action to limit climate change.

But the pressing need to discover whether the contending pollies have memorised a list of facts and figures has left little time for debating such minor matters as which side has the better policy on global warming.

And, whatever I may think, it’s clear most voters don’t rate climate change that highly. Recent polling by the Australian National University’s Centre for Social Research and Method shows voters rank reducing the cost of living most highly (65 per cent), followed by fixing the aged care system (60 per cent), strengthening the economy (54 per cent), reducing health care costs (53.5 per cent) and – at last – “dealing with global climate change” (just under 53 per cent).

But I’m pleased to say – and you may be surprised to hear – that the nation’s economists are in no doubt on what matters most. Three-quarters of the 50 top economists surveyed by the Economic Society of Australia nominated “climate and the environment” as the most important issue for the election.

Professor John Quiggin, of the University of Queensland, says the key message from the latest report of the Intergovernmental Panel on Climate Change is that “if the world acts now, we can avoid the worst outcomes of climate change without any significant effect on standards of living”.

But the report said it’s “now or never” to keep global warming to 1.5 degrees. Action means cutting emissions from the use of fossil fuels rapidly and hard. “Global emissions must peak within three years to have any chance of keeping warming below 1.5 degrees,” he says.

If you wanted to pick the worst continent to live on as the climate changes, it would be Australia, according to Quiggin. We are a “poster child” for what the rest of the world will be dealing with. Not that we care.

The economic costs of the transition to renewable energy would be marginal, he says. “The required investment in clean energy would be around 2.5 per cent of gross domestic product. That’s far less than the cost of allowing global heating to continue, with costs further offset by clean energy’s zero fuel costs and lower operating costs.”

Voters complain there’s no real difference between the parties, but on climate change we’re being offered the full menu of varying strengths. Climate Analytics, a non-profit research group founded by Bill Hare, has assessed three parties’ policies, plus Zali Steggall’s climate bill, which the teal independents are supporting.

The Liberals have supported zero net emissions by 2050, but refused to increase their commitment to reduce emissions 26 or 28 per cent by 2030. This is judged to be consistent with global warming of 3 degrees, bordering on 4 degrees.

Labor’s target is emission reduction of 43 per cent by 2030. Its plan is supported by the Business Council of Australia. This is judged to be consistent with global warming of 2 degrees, which would be “very likely to destroy the Great Barrier Reef”.

Steggall’s climate bill has a target of 60 per cent reduction in emissions by 2030, which is close to, but within, the upper boundary of modelled 1.5 degrees pathways for Australia. A higher target would give a higher probability of meeting the 1.5 limit.

The Greens’ target of a 74 per cent reduction by 2030 is judged consistent with limiting warming to 1.5 degrees. Some parts of the Barrier Reef would survive. Globally, the most extreme heat events could be nearly twice as frequent as in recent decades. In Australia, an intense heat event that might have occurred once a decade in recent times could occur every five years and would be noticeably hotter. Phew.

If you’ll forgive a little colourful characterisation, the choice ranges from the Liberals’ “let’s just say we’ll do something, so we don’t offend Barnaby and his generous donors” to Labor’s “let’s do a lot more than the Libs, but go easy on coal and coalminers” to the Greens’ “let’s not muck about”.

And the many Liberal voters in the party’s leafy heartland who really do care about climate change now have a way to make their views felt.

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Inflation: bad for your budget, good for the government's

A big part of the Morrison government’s pitch about being better at economic management than Labor is its claim to have ensured all the massive increase in unfunded government spending during the years of pandemic lockdowns was “targeted and temporary”. Well, not really.

In a paper written by Matt Saunders and Dr Richard Denniss, of the Australia Institute, they study the forecasts and projections out to 2025-26 in the latest budget, which those with long memories will remember was presented at the start of this seemingly endless election campaign.

The authors find that, relative to what was projected in the last budget before the pandemic, annual government spending is now projected to grow at a much higher rate. It’s true annual spending has fallen back from its peak in 2020-21, but not by nearly as much as it should have if all the extra spending had been “targeted and temporary”.

So, what’s happened? I think I know. All the spending programs specifically labelled as part of the effort to hold the economy together during the lockdowns – JobKeeper, the JobSeeker supplement and all the rest – have indeed been wound up as promised.

But last year’s budget and this year’s both contained new spending initiatives that were separate to the explicitly pandemic-related measures. These, like most spending measures, were ongoing. Their annual cost tends to rise over time, in line with inflation and population growth.

If you remember, last year’s budget included much additional spending on aged care in response to the shocking findings of the royal commission, extra spending on the National Disability Insurance Scheme and a big increase in childcare subsidies.

Another thing worth remembering about last year’s budget: whatever the obvious political motivation for that additional spending, the econocrats co-opted it for their Plan B: if after almost a decade trying you can’t get wages to return to their normal healthy growth, why not try getting unemployment down so low that employers have to bid up wages to get or retain the labour they need?

With under acknowledged help from the temporary closure of our borders to all imported labour, Plan B has worked so well it’s now adding to the risk of ongoing inflation arising from all the once-off imported inflation.

But perhaps the most startling thing revealed by the authors’ examination of the budget papers is the way, relative to the pre-pandemic figures, nominal gross domestic product is now projected to grow at quite a faster rate than real GDP.

Why would nominal grow faster than real? Clearly, because of a higher rate of inflation. Remember, however, here we’re talking about inflation measured not as usual by the consumer price index, but as measured by the “GDP deflator”.

Why would the two inflation measures give significantly different results? Because our “terms of trade” had changed. If the prices we receive for our exports are changing at a different rate from the prices we’re paying for our imports.

So the GDP deflator includes changes in export prices, and subtracts changes in the prices of imports, whereas the CPI ignores export prices, but does include changes in the retail prices of imported consumer goods and services.

We’ve been making so much fuss about the bad news of rising import prices, such as petrol and diesel, we’ve forgotten that, as a big exporter of energy and food, we’re a net beneficiary of the Ukraine war’s effect on world commodity prices.

With much additional help from high iron ore prices, our terms of trade improved by more than 12 per cent in the March quarter, to a record high. A record high, and no one noticed.

But here’s the trick: your personal budget benefits only indirectly, if all at, from our booming exports. But it will bear the full effect of higher import prices, which do most to explain why the cost of living is up 5 per cent in a year and headed higher.

The Reserve Bank is confident this year’s round of wage rises will be a fair bit higher than last year’s, but it is adding to home-buyers’ cost of living by putting up interest rates, to help ensure wages rise by a lot less than prices in the period ahead.

So, recent developments not good news for your budget, but great news for the government’s budget. Its revenue tends to grow in line with the growth in nominal GDP. And higher inflation means higher taxes.

Mining companies paying more company tax, consumers paying more goods and services tax and, even despite the continuing fall in real wages, higher income tax collections as whatever wage rise workers do get pushes them into higher tax brackets or otherwise raises their average tax rate. Good news for some.

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