Why our standard of living will be rising more slowly

You could call it gloom, or call it realism, but the likelihood is the economy will be growing more slowly from now on.

And we’re talking not just the next year or two – where the Reserve Bank’s rapid rise in interest rates means if we don’t go backwards, we’ll have been let off lightly – but the next maybe 40 years.

No one – not even economists – knows what the future holds, of course. But this long-term slowing is the considered guess of the secretary to the Treasury, Dr Steven Kennedy, who this week gave us his summation of the Treasury’s recent intergenerational report, which makes largely mechanical projections – not hard-and-fast forecasts – for the economy over the 40 years to 2063.

 Kennedy says the projections are “illustrative”. A key assumption on which they’re based, that present government policies don’t change, means the projections demonstrate “the longer-term implications of our current path”.

The report’s “aim is to avoid the risks projected … through ongoing improvement and reform of policy settings”.

Even so, I think we’re justified in concluding that the slower growth the report projects is more likely to eventuate than either unchanged or faster growth. That’s because so many of the factors likely to affect our future growth are beyond the government’s control.

The report projects that real gross domestic product – the nation’s total production of goods and services – having grown by an average of 3.1 per cent a year over the past 40 years, will slow to growth of 2.2 per cent a year over the coming 40 years.

How would this slowdown be explained? The Treasury’s standard way of analysing economic growth is to break it up into the three main drivers of growth – known as “the three Ps”: growth in the population, growth in the population’s participation in the labour force, and growth in the productivity of the workforce.

Notice how people-centred this way of chopping up economic growth is?

First. Population. Whereas our population grew at an average rate of 1.4 per cent a year over the past 40 years, it’s projected to grow by just 1.1 per cent over the coming 40.

These days, “natural increase” – births minus deaths – accounts for only about 40 per cent of the growth in our population, with “net overseas migration” accounting for the remaining 60 per cent.

The Treasury projects a further slow decline in our “fertility rate” – the number of births per woman – which has long been well below the 2.1 children “replacement rate” needed to hold the population steady over the years.

So we’ve long used high immigration to keep the population growing. Net migration fell sharply when we closed our borders during the pandemic. It has surged since the borders were reopened, but the Treasury expects it to fall back to 235,000 people a year once the surge has passed.

This level is what the Treasury projects for the rest of the years to 2063 – meaning that fixed number would fall as a percentage of the growing population. Even so, the population is expected to exceed 40 million in the early 2060s.

It’s just a projection, but I don’t have trouble believing immigration levels will decline rather than increase in the coming years. With all the rich countries – and China - having fertility rates well below the replacement rate, I can see far more competition for immigrants than there has been, especially since we only want skilled immigrants.

This expected slowdown in immigration means the overall size of the economy wouldn’t be growing as fast as it has been, but that doesn’t necessarily mean those of us who are already here will be worse off. That depends less on the economy’s overall growth and more in what’s happening to growth in GDP per person.

The report projects that, whereas real GDP per person grew by 1.8 per cent a year on average over the past 40 years, it will slow to 1.1 per cent a year over the coming 40.

Ahh. So, not just slower growth in the economy, but a much slower rate of improvement in our material standard of living. We’d still be getting more prosperous, but at a rate so small that it would be hard to notice.

And the problem must be coming from the other two Ps – participation and productivity improvement.

At present, the “participation rate” – the proportion of the working-age population that’s either in work or actively seeking it – is the highest it’s ever been, at 66.6 per cent, but the Treasury projects it will have fallen to 63.8 per cent by 2063.

Why? Because the proportion of the population aged 65 and over is projected to rise from 17 per cent to 23 per cent. So population ageing means more people will be too old to work.

But this will be countered to an unknown extent by more women of working age taking paid employment, and a healthier post-65 population choosing to keep working, even if only a few days a week.

However, most of the slowdown in GDP growth per person is explained by the expectation that the rate of improvement in the productivity of labour will be slower.

Whereas productivity improved at an average rate of 1.5 per cent a year over the past 30 years, it’s improved by only 1.2 per cent a year over the past 20 years – and that’s the rate the Treasury has projected over the coming 40 years.

There are plenty of reasons to expect productivity improvement will become harder to achieve. Just one is the greater share of GDP coming from the provision of labour-intensive services and the lesser share from the capital-intensive production of goods. It’s a lot easier to make machines more productive than do the same for people.

Finally, another reason for expecting population, participation and productivity to be weaker in coming decades is that various other rich countries’ experience is leading them to expect the same.

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Voting No? You may have this key assumption wrong

If you’re thinking of voting No in the Voice referendum because governments have been spending so much taxpayers’ money trying to “close the gap” without much sign of success, perhaps you need to reconsider. If the Voice to parliament of Aboriginal and Torres Strait Islander people is enshrined in the Constitution, obliging our politicians and bureaucrats to listen, chances are that money will be better spent.

But I can tell you now the message First Nations people will be trying to get across: we want the local spending on health and education and the rest to be administered by Indigenous-led local organisations.

Why? Because when you do it that way, the money’s spent by people with a much better understanding of what the problems are, and the best ways to go about fixing them. Because when the government’s being represented by Indigenous-run outfits, they get much more trust and co-operation.

I’ve realised this mainly by reading a report, Better Outcomes and Value for Money with a Seat at the Table, issued by the Lowitja Institute, a largely government-funded, Indigenous-controlled health research organisation, based in Melbourne.

Let’s start with some facts about government spending on Indigenous people.

According to the Productivity Commission’s most recent estimates, for the 2015-16 year, spending by all levels of government on Indigenous people totalled $33 billion, representing 6 per cent of those governments’ total spending of $556 billion.

Some mates of mine believe Aboriginal people get a lot of government money the rest of us don’t. Only $6 billion of that $33 billion was specifically targeted to Indigenous people. The remaining $27 billion was the share of ordinary spending on hospitals, education, aged care and, importantly, the justice system, used by Indigenous people.

Even so, that $33 billion represents average annual spending of $44,900 per Indigenous person, compared with $22,400 per non-Indigenous person.

Why are Indigenous people getting twice as much? Because they have more disadvantage than the rest of us, and so need more help. For instance, their burden of disease is 2.3 times that of non-Indigenous people, the report says.

Indigenous people “have survived centuries of systemic racism, economic and social exclusion, and intergenerational trauma. As a result, our peoples now die far earlier and experience a higher burden of disease, disability, poverty, and criminalisation than other Australians,” it says.

But here’s the upside. Because governments are spending so much, “slight improvements in the efficiency of the existing spend would generate substantial savings, both directly and through flow-on impacts to other policy areas,” we’re told. For a case study, read to the end.

The federal government first signed a statement of intent to work in partnership with Aboriginal and Torres Strait Islander peoples in 2008, to “achieve equality in health status and life expectancy … by 2030”.

This partnership was refreshed and strengthened in 2020 by a National Agreement on Closing the Gap, made between peak Indigenous community organisations and all federal, state, territory and local governments.

The agreement accepted four priority reforms: formal partnerships and shared decision-making, building and strengthening the community-controlled sector, transforming government mainstream organisations, and shared access to data and information at a regional level.

Are you getting the message? In practice, however, the report says, “these changes have been patchy and incremental despite increased investment from government”.

“An Aboriginal and Torres Strait Islander Voice could support more effective public investment in our wellbeing because our communities know what they need and how to deliver outcomes with the right support,” we’re told.

The report argues that government-run, top-down programs to close the gap haven’t worked as well as community-controlled initiatives.

Research indicates that Indigenous-controlled community health organisations “attract and retain more Aboriginal and Torres Strait Islander patients than mainstream providers, are more effective at improving our health, and see more significant health benefits per dollar of expenditure,” the report says.

It was Indigenous community health organisations that had the knowledge and expertise to rapidly respond to the especially great threat presented to their people by COVID-19.

Throughout the first year of the pandemic, just 147 cases of the virus were reported among Indigenous people, out of 28,000 total cases in Australia. There were no Indigenous deaths and no identified cases in remote Aboriginal communities.

In the second year, Indigenous community health organisations worked tirelessly to ensure their communities were vaccinated.

Turning to education, the report says the federal government’s “remote school attendance strategy”, begun in 2013, with total spending of more than $200 million over eight years, had seen falling attendance rates.

By contrast, the report argues, in 2017, the community-led Maranguka justice reinvestment project in Bourke achieved a 31 per cent increase in year 12 retention, a 23 per cent reduction in recorded rates of family violence incidents, and a 42 per cent reduction in adult days spent incarcerated.

These improvements were calculated to have saved the NSW economy $3 million that year – five times the project’s operating costs.

I’ve drawn my own conclusions from all this. So close to the vote, I leave you to draw yours.

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It's time for more sensible thinking on productivity

When will we tire of all the bulldust that’s talked in the name of hastening productivity improvement? We never do anything about it, but we do listen politely while self-appointed worthies – business people and econocrats, in the main – read us yet another sermon on the subject.

Trouble is, when the sermons come from big business – accompanied by 200-page reports with snappy titles – they boil down business lobby groups doing what lobby groups do: asking the government for special favours – aka “rent-seeking”.

You want higher productivity? It’s obvious: cut the company tax on big business, and give us a free hand to change our workers’ pay and conditions as we see fit.

When the sermons come from econocrats, they’re more like professional propagandising: calls for “reform” – often of the tax system – that are usually theory-driven and lacking empirical evidence that they really would have much effect on productivity.

What we get in place of genuine empiricism is modelling results. Models are a mysterious combination of mathematised theory, sprinkled with ill-researched estimates of elasticity and such like.

We’ve become so inured to all this sermonising that we’ve ceased to notice something strange: although in a market economy it’s the behaviour of business that determines how much productivity improvement we do or don’t get, any lack of improvement is always attributed to the government’s negligence.

This is where the business rent-seekers and the econocrat propagandists are agreed. The econocrats willingness to point at the government comes from the biases in their neoclassical theory, which assumes, first, that businesses always respond rationally to the incentives they face and, second, that government intervention in markets is more likely to make things worse than better.

Big business is happy to use this ideology to hide its rent-seeking. (If you wonder why neoclassical economics has been dominant for a century or two despite surprisingly little evolution, it’s partly because it suits business interests so well.)

The other strange thing we’ve failed to notice is that the modern obsession with the tax system and regulation of the labour market has crowded out all the economists’ conventional wisdom about what drives productivity improvement over the medium term.

But before we get to that wisdom, a health warning: there’s a famous saying in economics that the sermonisers have stopped making sure you know. It’s that, for economists, productivity is “a measure of our ignorance”.

Just as economists can calculate the “non-accelerating-inflation rate of unemployment”, and kid themselves it’s next to infallible, when you ask them why it’s gone up, or down, all they can do is guess at the reasons, so it is with calculations of productivity. Economists can’t say with any certainty why it’s up or why it’s down. They don’t know.

Even so, in the present opportunistic sermonising, all that the profession thought it knew has been cast aside.

Such as? That productivity improvement is cyclical and hard to measure. Recent quarterly results from the national accounts will probably change as better data come to hand, and the accounts are revised.

It’s true that the measured productivity of labour actually has fallen over the three years to June this year, but it’s likely this is, to a great extent, a product of the wild swings of the pandemic and its lockdowns. As Reserve Bank economists have argued, these effects should “wash out”.

It’s well understood that the main thing that improves the productivity of labour is employers giving their workers more and better machines to work with. But Australia’s level of business investment as a share of gross domestic product is low relative to other rich countries.

Growth in non-mining business investment has declined from the mid-2000s and stagnated over the past decade. It’s grown strongly recently, but it’s not clear how much of this is just tradies taking advantage of lockdown tax concessions to buy a new HiLux ute.

Point is, why do the sermonisers rarely acknowledge that weak business investment spending does a lot to help explain our weak productivity improvement?

Another factor that should be obvious is our recent strong growth in employment, the highest in about 50 years, with many people who employers wouldn’t normally want to employ, getting jobs. This will lower the workforce’s average productivity – but it’s a good development, not a bad one.

Again, why do the sermons never mention this?

Yet another part of the conventional wisdom it’s no longer fashionable to mention is the belief that productivity improvement comes from strong spending – by public and private sectors – on research and development. Have we been doing well on this over the past decade or so? I doubt it.

And, of course, productivity improvement comes from giving a high priority to investment in “human capital” – education and training.

So, why no sermons about the way we’ve gone for a decade or more stuffing up TAFE and vocational education, or the way school funding has given “parental choice” for better-off families priority over the funding of good teaching in public schools?

Too many of those sermons also fail to mention the small fact that all the other developed economies are experiencing similar weakness – suggesting that much of our poor performance is explained by global factors, not the failure of our government.

Related to this, the preachers usually compare our present performance with a much higher 30- or 40-year average, implying our weak performance is something new, unusual and worrying.

Or, we’re told that, whereas productivity improved at an annual rate of 2.1 per cent, over the five years to 2004, it worsened to 0.9 per cent over the six years to 2010, and improved only marginally to 1.2 per cent over the nine years to 2019, before the pandemic.

This is all highly misleading. The fact is that periods of weak improvement are more common than periods of strong improvement, which are rare.

Our period of unusually strong improvement from the late 1990s to the early noughties is paralleled by America’s strong period from 1995 to 2004, which the Yanks usually attribute to rapid productivity improvement in the manufacturing of computers, electronics and semiconductors.

We usually attribute our rare period of strong improvement to the belated effects of the Hawke-Keating government’s program of microeconomic reform. Maybe, but computerisation and the information revolution are a more plausible guess.

Either way, contrary to the sermonisers’ implicit claim that the present period of weak improvement is unusual, it may be closer to the truth that weakness is the norm, interspersed by occasional bursts of huge improvement, caused by the eventual diffusion of some new “general-purpose technology” – the next one likely to be generative AI.

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'Planetary boundaries' set the limits of economic freedom

One of the most important developments in economics is something in which economists had no hand: the identification of the environmental limits which humans, busily producing and consuming, cross at their peril.

Earth has existed for about 4 billion years and humans have lived on Earth for about 200,000 years. For almost all of that time we were hunters and gatherers, but 10,000 to 12,000 years ago we settled down, to farm and create civilisation.

It’s probably no coincidence that, for about that time, Earth has enjoyed a stable climate, with no more ice ages nor period of great heat, in which palms grew in Antarctica. This is the geological epoch called the Holocene, in which we live – although it may be ruled that we’ve moved to the Anthropocene, a new epoch in which the human species has made major alterations to the planet.

In its modern form, economics can be dated to 1776, when Adam Smith published The Wealth of Nations. Beliefs about how the economy works were well-defined by the time Alfred Marshall published Principles of Economics in 1890.

The point is that all economic activity – all the efforts of humans to earn a living – both depends on the natural environment and adversely affects it. By 1900, there were only about 1.6 billion humans on the planet, not enough to do much damage.

If we wrecked some area, we could just move to somewhere that hadn’t been wrecked, while the first bit gradually recovered.

So, at the time conventional economics was established, it was perfectly sensible to assume that the environment’s role in economic activity could be taken for granted. It was just there and it always would be. It was, as economists say, a “free good”.

When, from the 1700s, we started burning fossil fuel – coal, oil and gas – for heat, light and energy, we had no reason to worry that one day it might run out. It certainly never occurred to us that this might end up having an effect on the climate.

It took many decades before scientists began telling us that all the things we were doing to improve our lives – cutting down forests, damming rivers, drilling for water, ploughing, fertilising crops, fishing with nets – were damaging the soil, causing erosion, killing species, lowering the water table, and damaging the environment in other ways.

However, in just the past century or so, the world’s population has gone from 1.6 billion to 8 billion. Every extra human does a bit more damage to the environment. But that’s not the main thing. The main thing that’s changed is our use of advances in technology to hugely increase our standard of living and, in the process, massively increase the damage we’re doing to the environment.

Which brings us to “planetary boundaries”. In 2009, the Swedish scientist Johan Rockstrom and a scientist from the Australian National University, the late Will Steffen, with many helpers, established a framework listing the key categories of environmental damage, and estimating the amount of damage that could be done to each before the risk increased that “the Earth system” could no longer recover.

A second update of these estimates, led by an American oceanographer based in Copenhagen, Katherine Richardson, was released last month. With the ANU’s Professor Xuemei Bai, Richardson has written an article explaining the planetary boundaries.

There are nine boundaries. Three of them cover what we take from the ecological system: loss of biodiversity (extinction of species), loss of fresh water (pumping too much water from rivers and aquifers) and land use (deforestation).

Something economists didn’t know – or didn’t realise affected them – is that the laws of physics say we can never truly get rid of anything that exists on Earth.

All we – or the ecosystem – can do is change the form of the thing. Water can evaporate, but it’s still up in the clouds, for instance. We can cut down a tree, but as it slowly sinks into the dirt, it releases the carbon dioxide it had previously taken up.

This means that all our economic activity leaves in its wake a lot of waste. Not just landfill, but in many other forms.

So, the remaining six boundaries concern the waste our activity greatly adds to what would have occurred naturally. They are: greenhouse gases which cause climate change, ocean acidification (carbon absorbed by the sea), emission of chemicals that deplete the Earth’s ozone layer, “novel entities” (synthetic chemicals such as plastics, DDT and concrete), aerosols, and nutrient overload (nitrogen and phosphorus from fertilisers that wash into rivers and the sea, causing algae blooms, killing fish and coral).

Crossing any of these boundaries doesn’t trigger immediate disaster. But it does mean we’ve moved from the safe zone into dangerous territory. And the nine boundaries are interrelated and interacting, in ways we don’t yet fully understand.

In 2009, the scientists found we’d already crossed three boundaries: biodiversity, climate change and nutrient overload. By the 2015 update, a fourth boundary had been crossed: land use.

And by this year’s update, only three boundaries hadn’t been crossed: ocean acidification (but only just), aerosol pollution, and stratospheric ozone depletion – where an international agreement banning CFCs is slowly reducing the ozone hole we created.

Richardson and Bai say we’re now well into the danger zone, “where we – as well as every other species – are now at risk”. “We are eating away at our own life support systems,” they say.

One thing to be said for economists is that, unlike some, they don’t try to tell scientists how to do their job. Very few economists dispute the scientists’ evidence that climate change has been caused by human activities.

It was economists who developed the best means to reduce carbon emissions – emission trading schemes – which other countries have adopted, but Australia rejected.

When our governments decide to act on the other planetary boundaries, it will be economists who work out the best way to do it.

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We need economic growth to make us better off, right? Well, actually

For all our lives, worthies – our politicians, business people and economists – have assured us we need economic growth to make us better off. Almost everything I write assumes this to be true. But is it?

These days, there are more doubters than there used to be. Some people don’t believe that spending your life striving to own more stuff will make you happy. (Spoiler: they’re right.)

But a growing number of scientists tell us unending growth in the economy simply isn’t physically possible, and the more we keep growing the more we’ll damage the natural environment, to our great cost. Climate change is just the most glaring example of the damage we’re doing.

Historians remind us that our obsession with The Economy is relatively recent. It didn’t take hold until the middle of last century.

What we call “the economy” is all economic activity. It’s people getting up every morning, going out to earn a living, and then spending what they’ve earned. So it’s “getting and spending”, production and consumption. This is measured by gross domestic product – the value of all the goods and services produced during a period.

It was only when we started regularly measuring GDP in the mid-1950s that we began our obsession with whether it was growing and by how much. Or whether – God forfend – it was going backwards.

But these are just modern words and concepts. In truth, Australians have been preoccupied by what today we call economic growth since the day white people arrived. Their magic words were “settlement”, “progress” and “nation building”.

The recent arrivals saw a “new” nation where nothing had been done, but with huge potential for endless bush to be made to resemble the old country. They set about clearing the land, damming rivers, building houses, establishing farms and digging up minerals.

Why? To become more prosperous. They spurred themselves on with the belief they must “populate or perish” – be taken over by invading Asians.

So how do you achieve what we call economic growth? The easiest way is to grow the population. Have lots of kids and encourage (in those days, white-only) immigration. That gives you more people to work, but also more people needing to be fed, clothed, housed and entertained.

Bingo. A bigger economy. But while increasing the population makes the economy, GDP, bigger, it’s really only if the growth increases GDP per person that it can be claimed to make us better off, to have raised our material standard of living. And this doesn’t follow automatically.

The harder way to grow the economy is to increase the proportion of the population in paid employment, or to increase our investment in plant and equipment, and (well-chosen) public infrastructure. This does increase GDP per person.

But there’s another, more magical way to increase GDP per person. It’s to take the same quantity of resources – raw materials, labour and capital equipment – and use them to produce more output of goods and services than you did.

This is what people mean when they talk about increasing our “productivity”. It’s achieved, as economists keep repeating, by “working smarter, not working harder”.

How? By building a better educated and more skilled workforce, and by finding ways to make the organisation of factories and offices more efficient, but mainly by advances in technology that create better machines (and these days, computer programs) doing better tricks.

This is the bit scientists don’t get. When they hear the word “growth” they think of one thing: growth in humans’ exploitation of natural resources and all the damage we do to the environment in the process.

But that’s not what GDP measures. Economists know that most of the growth in GDP over the long term comes from increased productivity, not increased inputs of raw materials, labour and physical capital.

This means that, unless you believe there’s a limit to human ingenuity, it’s not true that continuing growth in GDP is impossible.

But when scientists say more clearly the kind of “growth” they’re referring to – growth in the use of natural resources and “ecosystem services” – it’s not possible to argue with the laws of physics.

While economists used to argue that the “limits to growth” weren’t as close at hand as some scientists had calculated, the possibility of the developing world enjoying the same profligate use of natural resources as the rich world is not credible. We expect the bottom 80 per cent to resign themselves to lives of relative poverty, while we in the top 20 per cent continue partying as though there’s no tomorrow.

So I accept that we and other rich countries will have to greatly constrain our use and abuse of the natural environment if the planet is to remain functional. A “circular economy” in which resources are so expensive that almost everything has to be repaired, reused and recycled? Sure.

But here’s the joke. It wouldn’t be the scientists who worked out how we could move to such an economy, it would be the economists.

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How full employment can coexist with low inflation

Who could be opposed to full employment? No one. Not openly, anyway. But Treasurer Jim Chalmers’ white paper on employment has been badly received by the Business Council and other business lobby groups. And, of course, business’s media cheer squad.

At least since Karl Marx, the left has charged that business likes unemployment to stay high so there’s less upward pressure on wages and workers are more biddable. We know that when, during recessions or lockdowns, bosses announce they’re skipping the annual pay rise, the unions never dare to disagree. Forget the pay rise and keep my job secure.

So you don’t have to swallow all the Marxist claptrap to suspect there may be some truth to the idea that, though businesses hate recessions, they don’t mind a bit of healthy unemployment.

If so, don’t expect them to be greatly enamoured of Labor’s latest resolve to pay more than lip service to the goal of full employment. But, by the same token, don’t be surprised if business happens to find in the full-employment package something they can profess to be terribly worried about.

Talk about speed reading. As is the practice in lobbyist-ridden Canberra, within minutes of the release of the white paper last Monday, the Business Council – like a lot of other business lobby groups – issued a full-page press release singing its agreement with the government’s move. It was all wonderful, and, in fact, just what the council had been calling for in its own recent voluminous report.

Until, suddenly, in the third-last paragraph, we discover the government had got it a bit wrong. Unfortunately, “we believe the federal government’s workplace relations reforms will undermine the objectives set out in the white paper.

“They will return the workplace relations system to an outdated model, unable to meet the expectations of both employees and businesses in the ways they seek to work today. It will risk fossilising industry structures and work practices when we know technology is going to change and people and workplaces need to adapt quickly,” the council says.

“If the government is to achieve the task it has set itself in this white paper, we encourage it to halt the current workplace relations changes and work constructively with business to identify challenges and find solutions that will deliver sustainable real wage increases for Australians.”

Ah, yes. Now we have it. And I’m sure all that would make perfect sense to every chief executive.

No, part of the opposition to the employment white paper comes from paper’s qualification to the definition of full employment as no one being jobless for long: “These should be decent jobs that are secure and fairly paid.”

But another part of the opposition has involved flying to the defence of the NAIRU – the “non-accelerating-inflation rate of unemployment” – which Chalmers now calls the “technical assumption” used by the Reserve Bank and Treasury in their forecasting, as opposed to the broader definition of full employment set out in the white paper.

The Australian Chamber of Commerce and Industry, the biggest employer group, said in its response to the white paper that the government “needs to make it clear that, contrary to trade union understandings, there will be zero impact on the Reserve Bank’s interest rate setting framework, and zero expectation that [it] will be more doveish on inflation”.

Well, not sure about that. Those who take the government’s recommitment to the goal of full employment to be a return to the post-World War II days when full employment was the only goal in the management of the macroeconomy are doomed to disappointment.

But those who happily imagine it will make zero difference are also kidding themselves. As the white paper makes clear, achieving sustained full employment involves “minimising volatility in economic cycles and keeping employment as close as possible to the current maximum level consistent with low and stable inflation”.

It doesn’t mean that, having fallen to about 3.5 per cent, the rate of unemployment must never be allowed to go any higher. No one has abolished the business cycle, nor the need for macro management to smooth the ups and downs in demand as the economy moves through that cycle.

So, the likelihood that, having greatly increased interest rates despite the fall in real wages, we’ll see some rise in unemployment in coming months, won’t prove the white paper was all hot air.

It’s also true, as more sensible business economists have realised, that the improvements in education and training that the white paper envisages could reduce “structural” unemployment, and thus the level of estimates of the NAIRU.

The truth is, economists make lots of calculations and the NAIRU is just one of them. While their calculations can tell them the NAIRU is now higher or lower than it was a few years ago, economists have never been able to tell you just why it’s changed.

The best they’ve ever been able to do is “ex-post” (after the fact) rationalisation. If the NAIRU has fallen, think of something that’s improved. If it’s risen, think of something that’s got worse.

The way the critics have rushed to the defence of the NAIRU, you’d think its magic number was written by God on tablets of stone. It’s just an estimate. And, like all estimates, it can be more reliable or less reliable.

No, what the government’s recommitment to full employment does is put full employment back up there as an economic objective equal in importance to low inflation. There’s always been scope for tension between the two objectives, and this increases that tension.

It says: if you’ve been erring on the side of low inflation, don’t. Try harder to find a better trade-off between the two.

It means the Reserve Bank and Treasury will now be less mindless and more mindful in the way they use the NAIRU to influence forecasts and judgements. But, unlike the critics, I think the Reserve and Treasury have already got that message.

As generator of magic numbers, the NAIRU has two glaring weaknesses. It was designed in an era when most jobs were full-time, so entirely ignores the spare capacity hidden in underemployment.

And, as the Reserve itself has acknowledged, it assumes all price rises are caused by excess demand, when we know that, in recent times, many price rises have come from disruptions to supply. And we know there’ll be more supply-driven pressure on prices from the transition to renewables and other things.

Have you noticed that whenever the Reserve and Treasury tell us their latest estimates of the magic number, they never tell us how much “judgment” they applied to the number that popped out of the model before they announced it?

But if that doesn’t convince you, try this one: the judgements the Reserve Bank makes will be better in future because, for the first time in a quarter of a century, Chalmers has appointed to its board someone who really knows how wages are set in the real world.

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Albanese wants to put full employment back on its throne

Something really important to the management of the economy happened this week: the Albanese government released its white paper on employment. If the government achieves the vision it has laid out, it could be a turning point in how our economy works, one that begins a lasting reduction in the rates of unemployment and underemployment.

This is Labor’s decision to put “full employment” back on its throne as a central objective of macroeconomic policy. Or, as the paper puts it, “placing full employment at the heart of our institutions and policy frameworks”.

For the first 30 years after World War II, the achievement of full employment was the overriding objective for the managers of the economy. This era began in 1945, with the Curtin Labor government issuing a white paper on full employment in Australia. Notice a pattern?

It worked well for 30 years, but fell apart with the arrival of high inflation in the mid-1970s. Since then, the primary concern of macroeconomic management has been to keep inflation low, with the goal of achieving full employment usually given not much more than lip service.

What’s changed has been the way the ups and downs of the pandemic have suddenly returned us to the lowest rate of unemployment in almost 50 years, about 3.5 per cent. But also the lowest rate of underemployment – part-timers who can’t get as many hours of work as they want – in several decades.

At present, we have about the highest proportion of the working-age population participating in the labour market – by having a job or actively seeking one.

This unexpected return to something close to full employment has prompted many people to think we should be trying at lot harder than we have been to keep employment high and unemployment low.

And that’s why the Albanese government has decided to put the goal of full employment back on its throne in the halls of macroeconomic management.

“Macro” means focusing on the economy as a whole. “Micro” means looking at particular bits of the economy, or at particular mechanisms within the economy.

Since World War II, governments have sought to use “fiscal policy” (the budget) and “monetary policy” (interest rates) to “manage” the macroeconomy by smoothing out the ups and downs in demand for (spending on) goods and services – and thus employers’ demand for workers.

If the goal of full employment is now back on centre stage, what does full employment actually mean?

The white paper defines it as where “everyone who wants a job is able to find one without having to search for too long”. But it adds a qualification: the jobs we create should be “decent jobs that are secure and fairly paid”, a requirement many employers won’t like the sound of.

The paper says it wants “sustained” full employment, which means “minimising volatility in economic cycles and keeping employment as close as possible to current maximum level consistent with low and stable inflation”.

So restoring the priority of full employment doesn’t mean ceasing to care about inflation, but does mean that getting serious about full employment will affect the day-to-day management of the macroeconomy.

The paper also says full employment must be “inclusive”: broadening the opportunities for people to take up paid work and lowering the barriers to work created by various forms of discrimination.

But how will the government go about achieving this more inclusive view full employment? Well, one way to answer this is to take the economists’ standard list of the types or causes of unemployment.

“Frictional” unemployment occurs because, at any time, there’ll always be some people moving between jobs or seeking their first job. So frictional employment is inevitable and nothing to worry about.

It occurs because it takes time for someone wanting a job to find someone wanting to give them one. You’d think that with so much advertising of job vacancies, and so much looking for jobs, occurring online, frictional unemployment ought to be lower than it used to be.

“Cyclical” unemployment is caused by downturns in the economy, which reduce employers’ demand for workers with little reduction in the people seeking work. As the paper says, it can be lessened through “effective macroeconomic policy settings”.

That is, to get the economy moving quickly out of a recession and, better, managing to stop it getting into recession in the first place. It’s when people lose their jobs during a prolonged recession – and education-leavers take months to find their first job – that you get a build-up in “long-term” unemployment.

These are the people who needed special, personalised help from the government because the longer they go unemployed, the less an employer wants to take them on. This role used to be played (not particularly well) by the Commonwealth Employment Service, which was replaced by what’s now called Workforce Australia, using often for-profit providers of “employment services” to people with problems.

If you’ve heard anything about robo-debt, it won’t surprise you that it’s become a travesty of what it was supposed to be, with providers gaming the system and gaining the impression the government wants them to punish people rather than help them.

The Albanese government has instituted an inquiry into the present system of government-funded employment services. How seriously it reforms this shemozzle will be a key test of how committed the government is to achieving sustained full employment.

The final type of unemployment is “structural”, caused by a mismatch between the skills a worker possesses and the skills employers are seeking. Sometimes the mismatch is geographic; often it’s caused by the ever-changing structure of industry, as some industries decline and others expand.

This is the hardest cause of unemployment to reduce. But it involves reforming every level of education and committing to retraining and lifelong learning. Again, this will be a key test of whether the government is committed to achieving sustained full employment, not just dreaming about it.

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Labor sets out its alternative to neoliberalism

If, rather than wading through all the things the Albanese government has decided to do, you read what its white paper on employment actually says, you realise a remarkable thing: it reveals a vision of an alternative economy the government wants to take us to.

In recent weeks we’ve seen before our eyes the worst of the economy that several decades of “neoliberalism” – the doctrine that what’s good for big business is best for the rest of us – has brought to us. The rise of the nation’s chief executives as commercial Brahman castes, taking short-cuts to higher profits by chiselling customers and mistreating employees, and seeing themselves as above the law, has left a sour taste.

Treasurer Jim Chalmers and his colleagues want to move from an economy centred on what the bosses want, to one centred on what’s best for the workers. It’s a shift from managing the economy for the few, rather than the many. The great majority of Australia’s households depend on income from wages.

The white paper spells it out from the beginning. “The government’s vision is for a dynamic and inclusive labour market in which everyone has the opportunity for secure, fairly paid work and people, businesses and communities can be beneficiaries of change and thrive. We are working to create more opportunities for more people in more places,” it says.

Our surprise return to our lowest rate of unemployment in almost 50 years – about 3.5 per cent, which we’ve maintained for more than a year – has revived the government’s ambition to pursue a goal we lost sight of in the 1970s, full employment.

The white paper says what the government takes that term to mean in our very different world, and how it will be pursued. Full employment has never meant an unemployment rate of zero. At the very least, there will always be a small proportion of workers moving between jobs or looking for their first job.

The paper announces the government’s definition of the term: it is working to create an economy where “everyone who wants a job is able to find one without having to search for too long”.

That’s a demanding specification. Sometimes unemployment will be high because the economy’s in recession. In normal times, unemployment is high precisely because too many people have gone for months without finding a job.

Some part of unemployment comes from the economy’s ever-changing industry structure, as some industries decline while others expand. This can leave some workers high and dry. They may have skills that some business wants, but that business may be many miles from where they live.

So for the government to commit to people not having to search too long to find a job imposes on it a great responsibility to help those people having problems.

But the government adds an important qualification to the requirement that no one be jobless for long: “These should be decent jobs that are secure and fairly paid.”

All this, it tells us, “is central to a strong economy and a prosperous and inclusive society”.

Just so. The only reason to want a strong economy is for prosperity that’s widely shared among the people who constitute the economy. And a simple truth that was lost in the era of neoliberalism is the value people place on having a job that’s secure.

It’s the peace of mind that comes from knowing that, if you turn up every day, do what you’re told and work hard, you can stop worrying about where your next meal’s coming from.

This can be just as important as how well the job pays, if not more so. But in recent decades we’ve seen the growth of businesses increasing their profits by using casualisation to make jobs less secure and devices such as labour hire and outsourcing to side-step existing wages and conditions.

The white paper says the government’s objective is “sustained and inclusive full employment”.

“Sustained full employment is about minimising volatility in economic cycles and keeping employment as close as possible to the current maximum level consistent with low and stable inflation.

“Inclusive full employment is about broadening opportunities, lowering barriers to work including discrimination, and reducing structural under-utilisation [part-time workers who can’t get as many hours of work as they want] over time to increase the level of employment in our economy.”

The paper says building a strong and skilled workforce “will be fundamental to achieving full employment and productivity growth”. This will require substantial growth in the high-skilled workforce.

“Australia needs an increasingly highly skilled labour force, equipped with the right tools and technology” to maximise gains from the transition to renewable energy, the increased use of artificial intelligence and the growing care economy.

Now, I know what you’re thinking. It would be a much better world to live in. But they’re just words ... just aspirations. True. But by setting it all down so formally, the Albanese government is raising our expectations.

It’s setting a standard for us to judge its performance by – a standard much higher than its predecessors ever set. We must hold Albo to it.

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What's kept us from full employment is a bad idea that won't die

Lurking behind the employment white paper that Treasurer Jim Chalmers will release today is the ugly and ominous figure of NAIRU – the non-accelerating-inflation rate of unemployment. If the Albanese government can’t free itself and its econocrats from the grip of NAIRU, all its fine words about the joys of full employment won’t count for much.

The NAIRU is an idea whose time has passed. It made sense once, but not anymore. The story of how this conventional wisdom came to dominate the thinking of the rich world’s macroeconomists has been told by Queensland University’s Professor John Quiggin.

In the period after World War II, economists decided that the managers of the economy faced a simple choice between inflation and unemployment. Low unemployment came at the cost of high inflation, and vice versa.

This relationship was plotted on something called the Phillips curve, and the economic managers could choose which combination of inflation and unemployment they wanted.

It seemed to work well enough until the mid-1970s, when the developed economies found themselves with high unemployment and high inflation at the same time – “stagflation” – something the Phillips curve said couldn’t happen.

The economists turned to economist Milton Friedman, who’d been arguing that, if inflation persisted long enough, the expectations of workers and businesses would adjust. The inflation rate would become “baked in” as workers and suppliers increased their wages and prices by enough to compensate for inflation, whatever the unemployment rate.

So, after much debate, the economists moved to doing regular calculations of the NAIRU – the lowest rate to which unemployment could fall before shortages of labour pushed up wages and so caused price inflation to take off.

Since the early 1980s, the economic managers have tried to ensure the rate of unemployment stayed above the estimated NAIRU, so inflation would stay low. Should inflation start worsening, central bankers would jump on it quickly by whacking up interest rates.

Why? So that expectations about inflation would stay "anchored". Should they rise, the spiral of rising wages leading to rising prices would push up actual inflation. Then it would be the devil’s own job to get it back down.

If this sound familiar, it should. It’s what the Reserve Bank has been warning about for months.

Trouble is, the theory no longer fits the facts. Inflation has shot up, but because of supply disruptions, plus the pandemic-related budgetary stimulus, not excessive wage growth. And there’s been no sign of a worsening in inflation expectations.

Wages have risen in response to the higher cost of living, but have failed to rise by anything like the rise in prices. Why? Because, seemingly unnoticed by the econocrats, workers’ bargaining power against employers has declined hugely since the 1970s.

Meanwhile, the stimulus took us down to the lowest rate of unemployment in almost 50 years, where it’s stayed for more than a year. It’s well below estimates of the NAIRU, meaning wages should have taken off, but shortage-driven pay rises have been modest.

All of which suggest that the NAIRU is an artifact of a bygone age. As Quiggin says, the absence of a significant increase in wage growth is inconsistent with the NAIRU, which was built around the idea that inflation was driven by growth in wages, passed on as higher prices.

“As a general model of inflation and unemployment, it is woefully deficient,” Quiggin concludes.

Economists have fallen into the habit of using their calculations of an ever-changing NAIRU as their definition of full employment. But it’s now clear that, particularly in recent years, this has led us to accept a rate of unemployment higher than was needed to keep inflation low, thus tolerating a lot of misery for a lot of people.

So if today’s employment white paper is to be our road map back to continuing full employment – if our 3.5 per cent unemployment rate is to be more than a case of ships passing in the night – we must move on from the NAIRU.

A policy brief from the Australian Council of Social Service makes the case for new measures of full employment and for giving full employment equal status with the inflation target in the Reserve Bank’s policy objectives – as recommended by the Reserve Bank review.

The council quotes with approval new Reserve governor Michele Bullock’s definition that “full employment means that people who want a job can find one without having to search for too long”.

But it says another goal could be added, that “people who seek employment but have been excluded (including those unemployed long-term) have a fair chance of securing a job with the right help”.

And it argues that “since an unemployment rate of 3.5 per cent (and an underemployment rate of 6 per cent) has not triggered strong wages growth, this could be used as a full employment benchmark”.

One of the things wrong with the NAIRU was that it was a calculated measure, and it kept changing. As Quiggin notes, it tends to move in line with the actual rate of unemployment.

“When unemployment was high, estimates of NAIRU were high. As it fell, estimates of NAIRU fell, suggesting that how far unemployment could fall was determined by how far unemployment had fallen,” he says.

Which is why, to the extent that econocrats persist with their NAIRU estimates – or the government sets a more fixed target – the council is smart to suggest a test-and-see approach.

Rather than continuing to treat a fallible estimate as though it’s an electrified fence – to be avoided at all cost – you allow actual unemployment to go below the magic number, and see if wages take off. Only when they do, do you gently apply the brakes.

The council reminds us that it’s not enough to merely aspire to full employment, or even specify a number for it. It’s clear that, apart from the ups and downs of the business cycle, what keeps unemployment higher than it should be is long-term unemployment.

Committing to full employment should involve committing to give people who have “had to search too long” special help just as soon as their difficulties become apparent.

This would be a change from paying for-profit providers of government-funded “employment services” to punish them for their moral failings.

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AI will make or break us - probably a bit of both

Depending on who you talk to, AI – artificial intelligence – is the answer to the rich world’s productivity slowdown and will make us all much more prosperous. Or it will lead to a few foreign mega tech companies controlling far more of our lives than they already do.

So, which is it to be? Well, one thing we can say with confidence is that, like all technological advances, it can be used for good or ill. It’s up to us and our governments to do what’s needed to ensure we get a lot more of the former than the latter.

If all the talk of AI makes your eyes glaze (or you’re so old you think AI stands for artificial insemination), let’s just say that AI is about making it possible for computers to learn from experience, adjust to new information and perform human-like tasks, such as recognising patterns, and making forecasts and decisions.

Scientists have been talking about AI since the 1950s, but in recent years they’ve really started getting somewhere. It took the telephone 75 years to reach 100 million users, whereas the mobile phone took 16 years and the web took seven.

You’ve no doubt seen the fuss about an AI language “bot”, ChatGPT, which can understand questions and generate answers. It was released last year and took just two months to reach 100 million users.

This week the competition minister, Dr Andrew Leigh, gave a speech about AI’s rapidly growing role in the economy. What that’s got to do with competition we’ll soon see.

He says the rise of AI engines has been remarkable and offers the potential for “immense economic and social benefits”.

It “has the potential to turbocharge productivity”. Most Australians work in the services sector, where tasks requiring the processing and evaluation of information and the preparation of written reports are ubiquitous.

“From customer support to computer programming, education to law, there is massive potential for AI to make people more effective at their jobs,” Leigh says.

“And the benefits go beyond what shows up in gross domestic product. AI can make the ideal Spotify playlist for your birthday, detect cancer earlier, devise a training program for your new sport, or play devil’s advocate when you’re developing an argument.”

That’s the optimists’ case. And there’s no doubt a lot of truth to it. But, Leigh warns, “it’s not all upside”.

“Many digital markets have started as fiercely competitive ecosystems, only to consolidate [become dominated by a few big companies] over time.”

We should beware of established businesses asserting their right to train AI models on their own data (which is how the models learn), while denying access to that data to competitors or new businesses seeking to enter the industry.

Leigh says there are five challenges likely to limit the scope for vigorous competition in the development of AI systems.

First, costly chips. A present, only a handful of companies has the cloud and computing resources needed to build and train AI systems. So, any rival start-ups must pay to get access to these resources.

As well, the chipmaker Nvidia has about 70 per cent of the world AI chips market, and has relationships with the big chip users, to the advantage of incumbents.

Second, private data. The best AI models are those trained on the highest quality and greatest volume of data. The latest AI models from Google and Meta (Facebook) are trained on about one trillion words.

And these “generative” AI systems need to be right up-to-date. But the latest ChatGPT version uses data up to only 2021, so thinks Boris Johnson and Scott Morrison are still in power, and doesn’t know the lockdowns are over.

Which brings us, third, to “network effects”. If the top ride-hailing service has twice as many cars as its rival, more users will choose to use it, to reduce their waiting times. So, those platforms coming first tend to get bigger at the expense of their rivals.

What’s more, the more customers the winners attract, the more data they can mine to find out what customers want and don’t want, giving them a further advantage.

This means network effects may fuel pricing power, entrenching the strongest platforms. If AI engines turn out to be “natural monopolies”, regulators will have a lot to worry about.

Fourth, immobile talent. Not many people have the skills to design and further develop AI engines, and training people to do these jobs takes time.

It’s likely that many of these workers are bound by “non-compete” clauses in their job contracts. If so, that can be another factor allowing the dominant platforms to charge their customers higher prices (and pay their workers less than they should).

Finally, AI systems can be set up on an “open first, closed later” business plan. I call it the drug-pusher model: you give it away free until you get enough people hooked, then you start charging.

Clearly, the spread of AI may well come with weak competitive pressure to ensure customers get a good deal and rates of profit aren’t excessive.

Just as competition laws needed to be updated to deal with the misbehaviour of the oil titans and rail barons of 19th century America, so too we may need to make changes to Australian laws to address the challenges that AI poses, Leigh says.

The big question is how amenable to competition the development of AI is. In other, earlier new industries, competition arose because key staff left to start a competing company, or because it made sense for another firm to operate in a different geographic area, or because customers desired a variant on the initial product.

“But if AI is learning from itself, if it is global, and if it is general, then these features may not arise.” If so, concentration maybe more likely than competition.

Get it? If we’re not careful, a few foreign mega tech companies may do better out of AI than we do.

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