Smarter thinking on budget is long overdue

I've been writing about the federal budget for 43 years, for 28 of which it's been in deficit.

So almost two-thirds of my career has been spent backing up Treasury in its recurring campaigns to pressure the government of the day to get the budget back to surplus. Sorry, not any more.

I've resigned from the budget-hectoring brigade because it finally dawned on me there has to be a better way.

You can put the blame for our eternally recurring budget crisis on the voters, whose demand for increased government spending is limitless, but whose willingness to countenance either spending cuts or tax increases is tiny.

Or you can blame the pollies – on both sides – who spend every election campaign pandering to and thus reinforcing this unreal thinking.

They wait until after elections to spring the bad news about the laws of arithmetic, then wonder why it's so hard to be economically responsible.

But I think some of the blame has to be shared with Treasury and Finance. It's true that treasuries – state as well as federal – accept ultimate responsibility for getting the budget back to balance. They care about budget balance above all other policy objectives.

Which is just as well. If Treasury didn't accept ultimate responsibility for fiscal rectitude, who do you reckon would? Certainly not the politicians, nor the media, nor the electorate.

That's why for so long I was happy to throw my puny weight behind Treasury's budget-repair campaigns.

I've stopped because, in all that time, there's been no sign of a learning curve. Treasury goes about attempting repair of the budget in just the same primitive way it did in the mid-1970s.

In all that time it's learnt almost no new tricks. It's applied no new science to its core responsibility of expenditure control, just kept on with the same old, same old simplistic cost-cutting approach.

Economists elsewhere have come up with inventive ways to make government spending more efficient and cost-effective: income contingent loans, activity-based health funding, the investment approach to welfare spending, early learning and other preventive programs, rigorous program evaluation and more.

Some of these techniques are being used in the federal budget, but not to the extent they should be and, to my knowledge, not because they were long championed by Treasury and Finance.

Indeed, it wouldn't surprise me if some had been opposed, or long-term investment in preventive medical programs sabotaged for a quick saving.

The best Treasury has come up with is the Orwellian annual "efficiency" dividend imposed on departments and agencies, and the rule that departments proposing new spending programs must also propose offsetting spending cuts of equivalent value.

Both crude devices have been relied on year after year, to the point where their economies are more likely to be false ones.

The efficiency dividend has become a euphemism for indiscriminate compulsory redundancies, which has robbed Treasury and Finance, and even the spending departments, of many of their policy experts.

Not to worry. If we need policy advice we'll buy it from one of the big accounting firms. They'll pretend to know what they're talking about and cost a fortune, but can be relied on to give us the recommendations we were hoping for.

The offsetting-savings rule has turned inefficiencies into valuable currency, to be husbanded jealously by their departments and given up only in return for equivalent spending increases.

It transfers responsibility for finding efficiencies away from the co-ordinating departments and into hands of departments just as likely to have been captured by the business interests they're supposed to be regulating.

The accountants of Finance can hardly be blamed for thinking like accountants. Trouble is, Treasury people too often think and act like accountants rather than economists.

They tend to view spending control as an annual scramble to knock the budget into shape, not a medium-term exercise in delivering value for money to the citizenry the government serves.

Too often they fail to consider the broader economic consequences of the cuts they push through. Like accountants, they think in terms of chopping spending down to the required size, not improving the efficiency and effectiveness of government service delivery.

They bang on about the nation's poor rate of productivity improvement while forgetting they themselves possess considerable scope to raise the efficiency of two of the economy's biggest and fastest growing industries, the two spending areas that dominate combined federal and state budgets and that will, unless made more efficient, do most keep budgets in crisis for decades to come: education and health.

No, no, leave that to the departments – or the other level of government.

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Reduced competition may be slowing US growth

US financial markets may be betting that the Trump administration's budget policies will stimulate economic growth and inflation, but they're cheered by this prospect only because of deeper fears that America and the advanced economies have entered an era of persistently weak growth.

America's rate of growth has been slowing for decades, starting long before the onset of the global financial crisis.

As part of this, America's rate of productivity improvement has been weakening, despite a short-lived uptick in the 1990s.

So the hunt's been on for factors that may be causing this slowdown. There are many suspects. But one you often see mentioned by economists such as Professor Paul Krugman is a decline in the strength of competition in many American markets.

If markets are significantly less competitive, you'd expect this to mean consumer prices that are higher than they might be, profits that are higher, less innovation, slower productivity improvement, worsening inequality and slower growth.

But what's the evidence of reduced competitive pressure? Earlier this year President Obama's Council of Economic Advisers issued a paper reviewing the evidence, which I'll summarise.

There are various ways to measure the degree of "concentration" in an industry – that is, how much of the business done by an industry is captured by a small number of large firms.

Figures collected by the US Census Bureau show that, over the 15 years to 2012, the share of total sales revenue earned by the 50 largest firms in 13 broad industry categories fell in three, was unchanged in one but increased in nine.

If 50 sounds like a lot of firms, remember this is America, whose economy is about 12 times bigger than ours.

Sales concentration was highest among utilities – electricity, gas and water – at 69 per cent, which isn't surprising considering many are natural monopolies. Even so, concentration increased by almost 5 percentage points.

After that came finance and insurance, where concentration was up by 10 percentage points to more than 48 per cent, followed by transportation and warehousing (up more than 11 points to 42 per cent) and retail trade (up 11 points to 37 per cent).

This picture is confirmed by studies of specific industries, the briefing paper says. One study of the national market for loans found that, over the 30 years to 2010, the top 10 banks' market share increased by 20 points to 50 per cent.

For deposits, the market share increased from 20 per cent to almost 50 per cent.

Another study found that, for hospital markets over the decade to 2006, a common measure of concentration increased by about 50 per cent, to a degree equivalent to having just three equal-sized competitors in a market.

A different measure of possibly reduced competition comes from looking at what's happened to the rates of profitability of big firms.

When researchers take the rates of return on invested capital for listed US companies, then rank them from highest to lowest, they find that for firms at the 90th percentile (that is, 10 per cent down from the top; 90 per cent up from the bottom) their rate of return is five times higher than for the median (dead middle) firms.

A quarter of a century ago, the 90th percentile firms' rate of return was closer to twice the median firms'.

This suggests some firms are better able to extract "economic rent" than they were. Economic rent is the profit you make that exceeds what you'd need to earn to be willing to remain in the industry.

Yet another indication comes from the "long-term downward trend in business dynamism", as indicated by a steady decline since the late 1970s in the proportion of new firms entering markets each year.

This is while the proportion of firms exiting markets each year has been little changed. Since the entry rate has now fallen to be equal to the exit rate, the total number of firms – which used to grow by about 6 per cent a year – is now unchanging.

Part of the explanation for the decline in the number of new firms could be rising "barriers to entry" into many industries.

This could be caused by increased federal, state or local licensing requirements, ever-rising economies of scale or data-mining information advantages to incumbent firms, or successful lobbying for government rules to protect against new entrants.

Labour market dynamism – how often workers change employers – has also declined since the 1970s.

This could have many causes, including no-poaching agreements between employers and greatly increased occupational licensing, which limits people's freedom to move between states.

The briefing paper notes it's not yet clear how these various indicators suggesting the US may be suffering a fall in competition within its markets fit together.

Turning to possible causes of reduced competition, it notes the problem of "common ownership". Researchers have argued that institutional investors who are large owners of the biggest firms in a particular industry, implicitly encourage those firms not to compete with each other, thus raising the investors' profits.

According to other research, the role of institutional investors has grown over the past 30 years so that, in 2014, they controlled 61 per cent of worldwide investment assets.

One anti-competitive development the briefing paper doesn't mention is the US Congress's willingness to keep extending the lives of existing and future patents and copyright.

Meanwhile, US government trade negotiators use bilateral preferential trade deals – going by the Orwellian name of "free trade agreements" – and plurilateral deals such as the Trans-Pacific Partnership agreement to press partners like us to extend the lives of our patents and copyright to fit with the Yanks' domestic arrangements.

Maybe one reason economic growth is slowing is that the world's multinational corporations are getting too good at finding ways to inhibit competition between them, including by enlisting the help of governments.

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