How the threat from robots was exaggerated

You'd have to have been hiding under a rock not to know that 40 per cent of jobs in Australia – about 5 million of them – are likely to be automated in the next 10 to 15 years.

Ask a young person what they know about the future of work and that's it. Which may help explain why so many of them seem angry and depressed about the economic future they're inheriting.

This information is widely known because it's the key finding of a major report, Australia's future workforce?, published in 2015 by the Committee for Economic Development of Australia, a well-regarded business think tank, derived from modelling it commissioned.

It's the sort of proposition you see many references to on social media, particularly because it chimes with a similar widely known prediction made in 2013 that 47 per cent of American jobs could be automated in the next 20 years.

Neither figure is a fact, of course, just a prediction about the distant future based on "modelling".

Why is it that if a prediction is big enough and gloomy enough, everyone keeps repeating it and no one thinks to question it? Why do we accept such frightening claims without asking for further particulars?

Why doesn't anyone ask the obvious question: how – would – they – know?

Because the prediction is based on "modelling"? That if it came out of a computer, it must be true?

Because the modelling for Australia reached similar results to the modelling for America? Sorry, it's actually the same model applied to different figures for each country.

Fortunately, not everyone is as easily convinced that the sky is falling. Two economists from Melbourne University, Professor Jeff Borland and Dr Michael Coelli, have taken a very hard look at the modelling undertaken for the committee by Professor Hugh Durrant-Whyte, of Sydney University, and other engineers at National Information and Communication Technology Australia.

Durrant-Whyte's modelling simply applies to Australia modelling of US occupations by Carl Frey, an economic historian, and Dr Michael Osborne, an engineer, of the Oxford Martin School for a sustainable future at Oxford University.

Frey and Osborne provided some colleagues with descriptions of 70 US occupations and asked them to judge whether they were "automatable" or not. This sample was then analysed and used to classify all 702 US occupations according to their likelihood of being automated.

Any occupation with a predicted probability of automation of more than 70 per cent was classed as being at "high risk" of automation.

Borland and Coelli make some obvious criticisms of this methodology. First, the colleagues found that 37 of the sample of 70 occupations were at risk of automation. Should these subjective assessments prove wrong, the whole exercise is wrong.

For instance, the colleagues judged that surveyors, accountants, tax agents and marketing specialists were automatable occupations, whereas Australian employment in these has grown strongly in the past five years.

Frey and Osborne say the need for dexterous fingers is an impediment to automation, but their method predicts there is an automation probability of 98 per cent for watch repairers.

Second, Frey and Osborne's modelling makes the extreme assumption that if an occupation is automated then all jobs in that occupation are destroyed. The advent of driverless vehicles, for instance, is assumed to eliminate all taxi drivers and chauffeurs, truck drivers, couriers and more.

Third, their modelling assumes that if it's technically feasible to automate a job it will be, without any need for employers to decide it would be profitable to do so. Similarly, it assumes there will be no shortage of the skilled workers needed to set up and use the automated technology.

More broadly, their modelling involves no attempt to take account of the jobs created, directly and indirectly, by the process of automation.

No one gets a job selling, installing or servicing all the new robots. Competition between the newly robotised firms doesn't oblige them to lower their prices, meaning their customers don't have more to spend – and hence create jobs – in other parts of the economy.

All that happens, apparently, is that employment collapses and profits soar. But if it happens like that it will be the first time in 200 years of mechanisation and 40 years of computerisation.

In 2016, the Organisation for Economic Co-operation and Development commissioned Professor Melanie Arntz and colleagues at the Centre for European Economic Research to offer a second opinion on Frey and Osborne's modelling.

Arntz and co noted that occupations categorised as at high risk of automation often still contain a substantial share of tasks that are hard to automate.

So they made one big change: rather than assuming whole occupations are automated, they assumed that particular tasks would be automated, meaning employment in particular occupations would fall, but not be eliminated.

They found that, on average across 21 OECD countries, the proportion of jobs that are automatable is not 40 per cent, but 9 per cent.

Those countries didn't include Oz, so Borland and Coelli did the figuring – "modelling" if you find that word more impressive – and found that "around 9 per cent of Australian workers are at high risk of their jobs being automated".

Why are we so prone to believing those whose claims are the most outlandish?

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Turnbull, Morrison holding their own on the economy

Whatever is holding Malcolm Turnbull and his government behind in the polls so consistently, it doesn't seem to be their handling of the economy.

Voters' responses to special questions in the September Fairfax-Ipsos poll are hardly a ringing endorsement of the Coalition's economic policies, but it is clearly ahead on points.

On which party has the best policies for managing the economy, the Coalition is preferred by 38 per cent of respondents, hardly overwhelming, but comfortably ahead of Labor's 28 per cent, with the Greens scoring a mere 3 per cent.

Decades of polling show voters almost invariably see economic management as one of the Coalition's comparative strengths. This poll shows that pre-judgment has not been shaken by the Turnbull government's struggles.

We need to remember, of course, that, since the Howard government's reforms more than 20 years ago, the day-to-day management of the economy is carried out by the Reserve Bank, not the elected government.

Since then, governments of all persuasions have benefited from the central bankers' steadying hand on the tiller.

As Treasurer, Scott Morrison has had his critics but, even so, his latest approval rating of 42 per cent exceeds his disapproval rating of 38 per cent.

And that's a vast improvement over Joe Hockey's position in April 2015, some months before he lost the job, when his disapproval exceeded his approval by 25 percentage points.

It's hardly surprising that Morrison's approval among intending Coalition voters far exceeds his approval among Labor voters.

What is surprising – and to his credit politically - is that his approval rating among Labor voters is almost double his disapproval rating among Coalition voters.

On the question of preferred treasurer, Morrison scored 38 per cent, comfortably ahead of Labor's shadow treasurer, Chris Bowen, on 29 per cent.

This, too, compares favourably with Hockey's margin of just 1 percentage point over Bowen in July 2014, just two months after Hockey's delivery of the government's hugely unpopular first budget.

This suggests Turnbull and Morrison's tactic in this year's budget of trying to bury all memory of that budget – and switch to using tax increases rather than spending cuts to repair the budget – is helping on the popularity front.

On the question of whether Turnbull or Tony Abbott has provided better economic leadership as prime minister, Turnbull's support of 56 per cent is more than double Abbott's 25 per cent.

Truly, Abbott and Hockey's popularity was unrecoverable after that disastrous first budget.

It's also noteworthy that, at 74 per cent, Labor voters' preference for Turnbull over Abbott far exceeds Coalition voters' preference of 66 per cent.

Some in Turnbull's party may see this as confirmation of his lack of conservative purity; the more savvy will see it as evidence of his potential to win votes from the other side if permitted to move closer to the "sensible centre".

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Sorry, but using migration to boost growth ain’t smart

Ask an economist where the growth in the economy will be coming from and it's surprising how often they fail to give the most obvious answer: from growth in the population.

Why don't they? Partly because it's an admission of failure: more people, bigger economy. Wow, that must have been hard to engineer.

Economists aren't supposed to believe in growth for its own sake. Their sales pitch is that economic growth is good because it raises our material standard of living.

But this is true only if the economy grows faster than the population, producing an increase in income per person (and even this ignores the extent to which some people's incomes grow a lot faster than others).

This simple truth is obscured by economists' practice of measuring growth in the economy without allowing for population growth.

Take the national accounts we got for the June quarter last week. We were told the economy grew by 0.8 per cent during the quarter and by 1.8 per cent over the year to June.

Allow for population growth, however, and that drops to 0.4 per cent and a mere 0.2 per cent. So, improvement in living standards over the past financial year was negligible.

Over the past 10 years, more than two-thirds of the growth in real gross domestic product of 28 per cent was accounted for by population growth, with real growth per person of just 9 per cent.

It's a small fact to bear in mind when we compare our economic growth rate with other developed countries'.

We usually do well in that comparison, but rarely admit to ourselves that our population growth is a lot higher than almost all the others.

Our population grew by 1.6 per cent in 2016, and by the same average rate over the five years to June 2016. This was slower than the annual rate of 1.8 per cent over the previous five years, but well up on the 20-year average rate of 1.4 per cent.

So in the past decade we've been relying more heavily on population growth – read, increased immigration – to bolster economic growth and make the improvement in our material prosperity seem greater than it is.

By now, much less than half our population growth comes from natural increase (births minus deaths) and much more than half from "net overseas migration" (immigration minus emigration).

Meaning, of course, that the even-faster rate of population growth over the past decade has been a conscious act of policy.

Almost all our business people, politicians and economists support rapid population growth through high migration. With that much conventional wisdom behind it, who needs evidence?

It's certainly rational for business people to support high migration. Their concern is to maximise their own living standards, not those of the rest of us, and what easier way to increase your sales and profits and salary package than to sell in a market that keeps expanding?

But I oppose "bizonomics" – the doctrine that the economy should be run primarily for the benefit of business, rather than the people who live and work in it – and the older I get the more sceptical I get about the easy assumption that population growth is good for all of us.

For a start, I don't trust economists enough to accept their airy dismissal of environmentalists' worries that we may have exceeded our fragile ecosystem's "carrying capacity".

But even before you get to such minor matters as stuffing up our corner of the planet, there are narrowly economic reasons for doubting the happy assumption that a more populous economy is better for everyone.

The big one is that the more we add to the population, the more we have to divert our accumulation of scarce physical capital – housing, business equipment and public infrastructure of roads, public transport, schools, hospitals and 100 other things – from "capital deepening", so as to improve our productivity, to "capital widening", so as to stop our productivity per person actually worsening.

The feds decide how much immigration we get, but it's the hard-pressed states that have to keep increasing their infrastructure spending to keep up with the needs of their ever-expanding populations.

But the states allow discredited American credit-rating agencies to limit how much they can borrow. And then there's the glaring inconsistency between believing in rapid population growth and the smaller-government brigade's eternal struggle to stop tax increases and limit government borrowing.

Is it any wonder the long-suffering denizens of our chronically under-serviced outer suburbs end up diverting so much of their dissatisfaction onto immigrants who arrive uninvited by boat? Sometimes I wonder if that's by design, too.

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Little Aussie battler battles on to future glory

Have you noticed how people are getting more upbeat about the economy? It's no bad thing. And, on the face of it, the figures we got this week confirmed their growing confidence.

The Australian Bureau of Statistics' national accounts showed that real gross domestic product grew by a very healthy 0.8 per cent in the June quarter. That's equivalent to annualised growth of 3.6 per cent.

But GDP growth is far too volatile from quarter to quarter for such calculations to make much sense (even though it's what the Americans do). And, just to ensure we don't get too confident, we have a media skilled in finding the lead lining to every silver cloud.

They lost no time in pointing out that half that growth came from increased consumer spending during the quarter of 0.7 per cent. But this return to strong growth was unlikely to be sustained because weak growth in wages meant much of the spending was covered not by an increase in household income, but by a decline households' rate of saving.

The household saving rate had fallen from 5.3 per cent of household disposable income to 4.6 per cent. Indeed, this was the fifth successive quarterly fall from a rate of 7 per cent in March 2016.

It's undeniable that we won't get back to truly healthy economic growth until we see a return to wages growing in real terms. And it's hard to know how long this will take.

Without doubt, weak wage growth is the biggest cloud on our economic horizon.

But the story on the decline in our rate of saving isn't as dire as the figures imply. Saving is calculated as a residual (household income minus consumer spending), meaning any mismeasurement of either income or spending - or both - means the estimate of saving is wrong, and likely to be revised as more accurate figures come to hand.

This time three months ago, for instance, we were told that for consumer spending to grow by 0.5 per cent in the March quarter, it was necessary for the saving rate to fall from 5.1 per cent to 4.7 per cent.

Huh? Obviously, the March-quarter saving rate has since been revised up 0.6 percentage points. How? By the bureau finding more household income. (The saving rate was revised up by lesser amounts in each of the previous six quarters.)

And it won't be surprising to see it happen again. We know that, according to the wage price index, average hourly rates of pay rose by 1.9 per cent over the year to June, whereas this week's national accounts tell us average earnings per hour fell by 0.8 per cent.

It's quite possible for the national accounts measure to show less growth than the wage index if employment is growing in low-paid jobs but declining in high-paid jobs, but it's hard to believe such a "change in composition" would be sufficient to explain so wide a disparity.

Moral: don't drop your bundle just yet.

A second line of negativity we've heard this week says much of the rest of the June quarter's growth came only from increased spending by governments, with government consumption contributing 0.2 percentage points and capital spending contributing 0.6 points.

Two points. First, increased spending on public infrastructure is no bad thing and, indeed, is exactly the budgetary support for stimulatory monetary policy (low interest rates) the Reserve Bank has long been calling for.

Second, the transfer of the new, private sector-built Royal Adelaide Hospital to the South Australian government during the quarter had the effect of overstating public investment for the quarter and understating business investment.

Looking at the adjusted figures for business investment, we find the good news that non-mining investment spending grew by (an upwardly revised) 2.1 per cent in the March quarter and 2.3 per cent in the latest quarter, to be up 6.1 per cent over the year to June.

That says the long-awaited recovery of business investment in the non-mining economy (the other 92 per cent) is well under way. It's also good to know that the long, growth-reducing decline in mining investment isn't far from ending.

Growth in home-building activity was negligible during the June quarter, although Treasurer Scott Morrison says there's a "solid pipeline of dwelling construction" remaining.

The volume of exports of goods and services rose by 2.7 per cent during the quarter, offset by a rise of 1.2 per cent in the volume of imports, implying a net contribution to growth of 0.3 percentage points in the quarter.

However, this was more than countered by a negative contribution of 0.6 percentage points from a fall in inventories, mainly a rundown of the grain stockpile. (That is, grain produced in an earlier quarter was exported in the latest quarter.)

Rural export volumes rose by 18.7 per cent over the year to June. Exports of services were also strong, having averaged annual growth of more than 7 per cent over the past three years, driven by exports of education and tourism.

So, overall, economic growth in the June quarter was a mixed picture which, following a contraction of 0.4 per cent in September quarter last year and - also weather-related - weak growth of 0.3 per cent in March quarter this year, amounted to growth of just 1.8 per cent over the year to June.

This is artificially low, but the September quarter should see us bounce up to artificially high annual growth of about 3 per cent, as last September quarter's minus 0.4 per cent drops out of the calculation.

If you want more persuasive support for our more optimistic mood, however, don't forget employment grew by a super-strong 214,000 in just the first seven months of this year – with 93 per cent of those jobs full-time – and leading indicators showing more jobs strength to come, plus surveys of business conditions showing them at their best in almost a decade.

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It's business that has the greatest sense of entitlement

How the worm – and the world – turns. When the Abbott government came to power just four years ago, it claimed its arrival signalled the "end of the age of entitlement". Don't laugh, it's happening – but in the opposite way to what treasurer Joe Hockey had in mind.

As Hockey saw it, the sense of entitlement we'd acquired, but which could no long be afforded, applied to the social needs of individuals and families.

We saw the results of this attitude in Tony Abbott and Hockey's first budget of 2014, which got an enormous thumbs-down from the public and the Senate, so that pretty much all that remains of the attack on unwarranted entitlement is the unending crusade by the government's Don Quixote, Christian Porter, and his loyal Sancho, Alan Tudge, to root out the last welfare cheat.

Not content with the grand stuff-up that was the "robodebt" use of unguided computers to collect amounts that may or may not have been overpaid, the pair are now hot on the trail of drug-taking welfare recipients.

Drug testing isn't cheap, so it's likely the exercise will cost the taxpayer more than it saves. And drug care experts – who weren't consulted - say addicts can't be successfully coerced into treatment.

Trouble is, successive governments have been cracking down on the crackdown on welfare cheats every year for decades, so there can't be all that many of 'em left.

Why do I get the feeling that cracking down on welfare cheating is, at best, what governments do when they want to be seen to be cutting their spending but aren't game to.

Or, at worst, when they want to exploit the popular delusion that we could all be paying less tax if it weren't for the massive sums being siphoned off by dole bludgers and the like.

Sorry, the people doing by far the most to keep welfare spending high and rising are known as age pensioners. And no one has a stronger sense of entitlement than an oldie fighting for the pension. "I've paid taxes all my life . . ."

But though one of Aussies' less attractive traits has been our proneness to "downwards envy" – the delusion that people worse-off than us are doing it easy – polling by the Essential organisation suggests it may be wearing off, replaced by disapproval of wealthier tax dodgers.

Essential finds only 12 per cent of respondents (including 14 per cent of Coalition voters) are "bothered a lot" by "the feeling that some poor people don't pay their fair share", whereas 53 per cent (40 per cent of Coalition voters) are bothered a lot by "the feeling that some wealthy people don't pay their fair share".

Ask whether they're bothered a lot by the feeling that "some corporations" don't pay their fair share, and disapproval shoots up to 60 per cent, including 51 per cent of Coalition voters.

It's a sign of the times. It has finally dawned on us that the people with the overweening sense of entitlement are our business people.

They used not to be so arrogant, but more than three decades of neoliberal ideology – under which governments should do as little as possible to burden the private sector or restrict its freedom – have left business people convinced they're demi-gods, the source of all goodness and justly entitled to our approbation and genuflection.

They're the source of all jobs, and thus entitled to have their every demand satisfied.

Why should chief executives earn up to 300 times what their workers earn? Isn't it obvious?

Why should the chief executive's package rise by 8 per cent while his workers' wage rise is held down to 2 per cent because times are tough? Because I've just realised that Joe Blow over at XYZ Corp is getting more than me, and I'm better than him.

Why should companies doing legal contortions to minimise the tax they pay, hesitate to demand a cut in the rate of company tax in the name of creating jobs?

The developed world is still recovering from the carnage of the global financial crisis, caused by letting American banks do hugely risky things in the pursuit of higher profits and bonuses, confident in the knowledge that, should things come unstuck, the government would bail them out.

We weren't so silly as to let our own banks behave like that, but the years since then have seen a litany of banks mistreating their customers, as their managers put bonuses ahead of service and the four big banks compete single-mindedly for the highest rate of profit.

Meanwhile, journalists are uncovering a remarkable degree of lawlessness by other businesses: young people paid less than their legal entitlement, exploitation of foreign workers on visas, employers failing to pay in their workers' super contributions.

It's as though business people see themselves as so economically virtuous as to be above the law. Just a bit of red tape those gutless pollies have yet to clear away.

What's changed with the end of the era of neoliberalism, however, is the willingness of politicians on both sides to toughen up on the banks and other businesses.

They'll be paying more rather than less tax in future, and governments are already far less hesitant to regulate them more closely.

I see a lot more coming. Why? Because voters have got jack of arrogant business people.

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Econocrats’ job to minimise damage from lurch to populism

With the collapse of the "neoliberal consensus" between both sides of politics, which is reversing politicians' attitudes to intervention in markets, we're in danger of lurching from one extreme to the other.

My Financial Review colleague Alan Mitchell likes to say that one of the econocrats' primary contributions to good government is to "keep the crazy decisions to a minimum". Never was that truer.

The challenge for Treasury, the Productivity Commission and the rest is to be less doctrinal – less true to the one true economic rationalist faith - and more practical in giving advice that satisfies the pollies' ever-present need to "do something" without the something they do causing a lot of harm, maybe even some good.

To put that into econospeak: econocrats should stop proposing first-best solutions and propose more politically palatable second- or even third-best solutions than have been properly thought through.

Why should they compromise? Because if they go on strike, get the sulks or just let themselves be dealt out of the policy decision process, we'll all be lumbered with a lot of decisions that make things worse rather than better.

That's particularly so now ministers' offices are loaded with pushy young punks at the start of their lifetime careers in politics, who think they know a lot about what's good for the minister and the government but, unfortunately, haven't had the time or inclination to learn much about policy: what works and what doesn't.

Leave a policy vacuum and these chancers will happily fill it. They'll fill it with whatever will get a cheer from the all-indignation-and-no-responsibility radio shock jocks and tabloid loudmouths.

Those reptiles will cheer for what's showy and prejudice-satisfying, not for less spectacular policies the experts know are more likely actually to improve things.

The point is that with the populist reaction against what it's now fashionable for the often-uncomprehending left to call "neoliberalism", we're moving from 30 years of presumption against intervention in markets to a new era of presumption in favour of intervention.

That presumption against intervention came from the 1980s shift to a more fundamentalist approach to neo-classical economics, with its confidence that markets are essentially self-correcting, so intervening in them is more likely to derail this process than assist it.

This involved playing down the significance of "market failure" – factors that stop real-world markets from acting in the perfect way economics textbooks predict they will – or arguing that government interventions to correct market failure usually result in "government failure" – they make the problem worse rather than better.

The rationalists were wrong to play down market failure – it's ubiquitous – and wrong to denigrate government rule-setting for markets as "intervention", as though it's some kind of unnatural act. But they were on to far more than they realised in worrying about government failure.

What ended up discrediting their program of "micro-economic reform" was the way so many privatisations and attempts to make the provision of government services "contestable" were utterly stuffed up by governments that didn't know what they were doing, or were swinging one for their business mates.

Though it's true people have traded with each other since primitive times, it's historical ignorance to imagine that markets in the modern economy are anything other than the creation of governments, regulated and policed under laws of private property, contract, bankruptcy, limited liability, accounting standards and a host of other "interventions" and "regulations".

So there isn't and never has been such an animal as a "free market". What's in question is the degree of regulation and the specifics of what's regulated and how. Presuming against regulation (further or existing) was always an arbitrary and extreme position that would end in tears.

The era of deregulation has discredited itself, with inadequately regulated American and European banks causing the pain and destruction of the global financial crisis, declining standards of business behaviour much in evidence among our own banks, and mounting evidence of business lawlessness.

But for politicians to react to all this with a massive increase in ill-considered regulation would hardly be an improvement.

The real point is regulation is neither intrinsically good nor bad. What it is is very, very tricky. Very hard to get right; easy to get wrong. Bedevilled by "unintended consequences".

Why? Because of the terrible power of "market forces" – actually, profit-seeking firms and self-interested consumers.

There are two mistakes you can make when it comes to regulation: one is to believe market forces are infallible, the other is to believe they're of little consequence and incapable of utterly frustrating the regulators' good intentions.

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Turns out productivity's been fine all along

What a joke. A scholarly article in Treasury's latest Economic Roundup has admitted that all the years of handwringing over our poor productivity performance was just jumping at shadows.

Turns out all the angst was caused by not much more than the figures being distorted by the mining industry's construction boom.

This after our top econocrats gave speech after speech urging "more micro reform" to improve productivity and keep living standards rising. (They'd have advocated more reform even if productivity was improving at record rates; its supposed weakness was just a convenient selling proposition.)

Meanwhile, the business lobby groups, led by the Business Council of Australia, claimed – without any evidence – the supposed weakness had been caused by the "reregulation" of wage fixing under Labor's evil Fair Work changes, and demanded the balance of bargaining power be shifted yet further in favour of employers. (A claim even the Productivity Commission wasn't convinced by.)

Even at the time, it seemed the contortions of the mining industry during the decade-long resources boom were a big part of the story, but that didn't stop people who should have known better going into panic mode.

"Despite concerns", the paper by Simon Campbell and Harry Withers, says with masterful understatement, "Australia's labour productivity growth over recent years is in line with its longer-term performance.

"In the five years to 2015-16, labour productivity in the whole economy has grown at an average annual rate of 1.8 per cent.

"This compares to an average annual rate of 1.4 per cent over the past 15 years, and 1.6 per cent over the past 30 years," it says.

Let's take a step back. Productivity compares the quantity of the economy's output of goods and services with the quantity of inputs of resources used to produce the output.

When output grows faster than inputs – as it does most years – we're left better off. This improvement in our productivity is the overwhelming reason for the increase in our material standard of living over the years and centuries.

Productivity can be measured different ways. The simplest (and least likely to be inaccurate) way is to measure the productivity of labour: growth in output per worker or, better, per hour worked.

Labour productivity improvement is caused by two factors. The first is by increases in the ratio of (physical) capital to labour used in the economy.

This known as "capital deepening" – translation: giving workers more tools and machines to work with, which makes them more productive.

The second driver of labour productivity is improvements in the efficiency with which labour inputs and capital inputs are used, arising from such things as improved management practices. This is known as MFP – multi-factor productivity.

In recent years the figures have shown multi-factor productivity growth to be zero or even negative, causing great concern among some economists, including the Productivity Commission.

But Campbell and Withers argue this focus on MFP is misplaced. They remind us that MFP is calculated as a residual (the product of a sum), meaning its likelihood of mismeasurement is high.

And they criticise the conventional view that physical capital should grow no faster than output – known as "balanced growth" - because capital deepening is an inferior source of productivity improvement to MFP.

People take this view because (making the unrealistic assumption that the economy is closed to transactions with foreigners) increased investment in physical capital must come at the expense spending on consumption.

The authors point out that achieving improved MFP isn't costless, while the price of capital goods (most of which are imported) has fallen persistently relative to the price of consumption goods.

"This has allowed Australia to sustain its high rate of capital deepening without forgoing ever higher levels of consumption," they say.

Actually, they say, our economy has never fitted the "balanced growth" story. Of the 30-year average of 1.6 per cent annual growth in labour productivity, MFP contributed only 0.7 percentage points, while capital deepening contributed 0.9 points.

Next the authors examine the causes of the ups and downs in labour productivity improvement overall by breaking the economy into six sectors: agriculture, mining, manufacturing, utilities, construction and services (everything else).

They find that labour productivity in agriculture is now 2 1/2 times its level in 1989, but it's too small a part of the economy – 2.5 per cent – for this to make much difference to the economy-wide story.

The utilities sector showed strong productivity growth until the turn of the century, before steadily declining through to 2011-12, mainly because of one-off developments such as the building, then mothballing of many desal plants.

The story of mining is well-known: its productivity fell because of the delay between companies hiring more workers to build new mines and gas facilities and that extra production coming on line. Since 2012-13, however, mining productivity has shot up. What a surprise.

Productivity in manufacturing and construction has grown at similar rates to the economy overall, as has productivity in the services sector (hardly a surprise since services now account for 70 per cent of gross domestic product).

Over the past five years, more than half of our total labour productivity improvement was attributable to the services sector, compared with about a quarter attributable to mining.

Apart from productivity improvement in the various sectors, overall productivity can be affected when changes in the industry structure of the economy cause workers to shift from lower-productivity sectors to higher-productivity sectors, or vice versa.

Because mining, being highly capital-intensive, has by far the highest level of labour productivity, the authors say it's really only when workers move in or out of mining that structural change has much effect on economy-wide productivity.

"These movements of labour into and out of mining have been the key driver behind the fluctuations in ... aggregate labour productivity growth," the report concludes.

Now they tell us.

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THE CHANGING ECONOMICS OF WAGES AND THE LABOUR MARKET

Talk to VCTA Teachers Day, Melbourne, Friday, September 1, 2017

I want to talk to you about the changing economics of wages and the labour market. Some of what I say may be news to you, some of it will, I hope, bring back to you stuff you haven’t thought about for a long time. What I say is intended more for your own edification – or re-edification – than for you to take straight into the classroom and lay on your students. One of the purposes of Professional Development is, after all, to ensure that you know a lot more about the subjects you teach than your students do.

The neoclassical model

One of the things I’ve noticed in my career as an economic journalist is the gap in thinking between economists who specialise in the study of a particular market or industry – the labour market, for instance, or the health industry, or even the education industry – and other economists who specialise in a different aspect – monetary economics, fiscal policy – or have no particular specialty. The specialists specialise in knowing about all the peculiarities of their market – all the special cases of market failure - that make it different from other markets and much harder to analyse. By contrast, the non-specialists “specialise” in using the same generalised, simple neoclassical model to analyse all markets on the assumption that all markets, being markets where prices change to equilibrate supply and demand, are pretty much the same.

I’ve noticed this one-model-fits-all approach particularly among policy advisers – Treasury, the Productivity Commission, PM&C, the Reserve Bank – but it has become more common since the rise to intellectual dominance in the early 1980s of what we used to call “economic rationalism” and now have joined the rest of the world in calling “neoliberalism”. This move to a more fundamentalist approach to economic analysis was very much about playing down the incidence of market failure and using the same simple, price-driven model to explain everything. Its great attractions are its simplicity, its clear predictions and its clear prescriptions on how problems should be solved. One sign of reversion to a more fundamentalist approach has been the willingness of economists to advocate – or, at the very least, accept in silence – the push for a return to individual contracting between workers and their bosses. Of course, this “neoliberal consensus” is now breaking up before our eyes under the onslaught from Brexit, Trump and the Redheaded One, and I’ll present you with some evidence of changing attitudes in academia and among Australian policy advisers.

The high school economics syllabus contains a far bit about the changing institutional arrangements for wage fixing in Australia, but doesn’t dwell on the micro theory of how wages are set by a firm or an industry. The syllabus’s Keynesian approach to macro management implies acceptance, at least at the macro level, of the Keynesian emphasis on wages being sticky downwards, with the implication that adjustment to shocks in the labour market comes less via changes in prices (wage rates) than via changes in quantities (employment and unemployment).

Even so, at the micro level, the syllabus carries an implicit acceptance of the neoclassical story that wage rates are set at the point where the marginal revenue product of labour curve crosses the labour supply curve and, of course, the market clears. A key explanatory variable is the elasticity of demand for labour, which is the effect on employment of a change in wages. This simple analysis is, of course, part of the model of perfect competition.

The unsuitability of the simple model

 But you don’t have to think hard before you realise that, when it comes to the labour market, the unsuitability of the simple neoclassical model runs a lot deeper than just the many respects in which all real-world markets fall well short of the assumptions of perfect competition. The most glaring respect in which the labour market differs from all other markets, whether markets for goods or markets for the factors of production, is that the rest involve the purchase or sale of inanimate objects, whereas each unit of labour purchased or sold comes with a human being inextricably attached. This obvious truth has many implications for the way labour markets work.

Perhaps the first person to formally note this truth was Alfred Marshall, the (British) father of neoclassical economics – the “marginalist revolution” – in one of the later editions of his magnum opus, The Principles of Economics, first published in 1890, which was the dominant textbook used in university economics courses throughout the English-speaking world until it was displaced by Keynes’s General Theory in the 1940s.

Surprisingly, given its history of neoclassical orthodoxy, this unique feature of labour – its inseparability from the humans delivering it – was readily acknowledged by the Productivity Commission in its report on the Workplace Relations Framework in late 2015. The report’s first “key point” is that “a workplace relations framework must recognise two enduring features of labour markets” the first of which is that “labour is not just an ordinary input. There are ethical and community norms about the way in which a country treats its employees” (page 2). This is true enough, but I’d have thought it was a strange way to put it. If you except that economies are run for the benefit of the people living in them, then the real point is not that it’s “unethical” to treat workers badly, but that the vast majority of people living in any economy are employees or their dependents. People are ends in themselves, not means to an end in the way that inanimate objects are merely means to human ends.

Further in (page 83), the PC says that “Labour market outcomes do not just affect economic performance — they also have a substantial impact on equality of opportunity, the stability of family relationships and social cohesion more generally. The ethical and social dimensions of the labour market form the basis for many aspects of the WR system that differentiate it from the regulation of other markets.

“For example, the ‘price’ of labour differs from the price of most other inputs in an economy. A broad principle underpinning Australia’s competition policy framework is that lower prices from competition are almost always desirable. In labour markets it is less clear that a lower price is necessarily desirable, given that many people’s incomes and wellbeing depend to a considerable extent on the price of labour and it can be costly to use alternative mechanisms to redistribute income. Indeed, the existence of a minimum wage — a ‘floor price’ set by regulation, which would usually be seen as contrary to the public interest for other goods and services — illustrates this distinction.”

In a nearby section of the report headed Human complexities (page 86), the PC acknowledges further implications of the labour market’s animate rather than inanimate nature:

“In the real world, employers and employees are people with all their various flaws and virtues, and these can collide in workplaces in ways that have ramifications for how labour markets function:

• People make mistakes (for example, employers and employees may form an employment contract without any real due diligence).

• Employers and employees have values that are important to the way they do their work. An employee may want to work many additional hours at no cost because of professional pride. Employers may want to pay bonuses, provide better staff facilities or assist an employee facing family problems (say domestic violence) because they are dealing with human beings who they wish to help and please. Employers and employees dealing with each other are not merely doing so as part of a calculated business strategy, and in some cases this opens the door for one party to exploit the other’s goodwill and non-monetary motivations. (One less altruistic formulation of this is that employers may sometimes set higher prices for labour to motivate trust and to increase the cost of shirking — one example of so called ‘efficiency wages’.)

• There are few ‘representative’ employers and employees. People have heterogeneous tastes for workplace conditions and heterogeneous abilities, even when paid the same wage rate.

• Some businesses are poorly managed, and most are not at the technological and managerial frontier. An inadequately managed firm may provide poor training, treat people poorly, leave them bored or over busy with poor task scheduling, pay them too little for what they do, or provide no praise for good work — and yet people do not leave the first time they are ill-treated. On the other hand, there are model employers, with a spectrum of employers between the two extremes. The poorest performing employers may fail ultimately, but failure usually takes time, and damage in the interim may not be limited to just the employer. There is a persistent poorly performing tail in the distribution of firm performance in all countries and all industries.

Some of the above complexities suggest a need for regulation, others not. For example, regulation of unfair dismissal is justified, not only because the act itself is problematic but also because the potential to do it allows leverage by an employer to exploit vulnerable employees. Bullying would fall under the same category (whether by an employee or employer). Voluntary consent to work longer hours than the average is not an obvious problem, unless it is actually not ‘voluntary’, but obtained through coercion.”

Market failure in labour markets

The fact that the labour market is so personalised – workers are people, but so too are bosses – means that many of the usual respects in which all real-world markets differ from perfect competition, all the common or garden categories of market failure, are a lot more significant in the case of the labour market. For instance, why are wages sticky downwards as Keynes told us? Because of the human factor. Because employers know that cutting workers’ nominal wages makes them very unhappy and likely to be less enthusiastic about doing their jobs well. Much better during a recession to just leave nominal wages unincreased and wait for continuing inflation to reduce them in real terms. (This, by the way, is why sensible macro managers like to see some price inflation: it makes it easier to cut real wages when sometimes you need to.)

Speaking of the more standard reasons the labour market falls short of perfect competition, the PC’s report offers a good list of them (page 85):

“• information asymmetries. Jobseekers may find it difficult to know the extent of competition for a job, the standard levels of remuneration and conditions for a comparable employment opportunity, and the non-wage conditions of a new workplace — such as workplace morale or the behaviour of managers. For employers, it may be similarly difficult to evaluate a potential employee’s skills or personal attributes, and other opportunities or offers the employee is considering. These gaps in information increase the uncertainty of rejecting an offer during negotiations. Even where parties can overcome these information gaps, this is likely to come at a significant cost.

• search costs. Job searching is costly, as is recruitment. It is also an uncertain process — parties usually make and receive offers in a sequential fashion, and so must consider the likelihood of receiving a better offer or applicant in the future. For workers whose skills or knowledge are not easily transferable between jobs, the financial costs and time taken to switch between employers or job sectors may be particularly high.

• impediments to individuals freely entering and exiting the labour market. Many people do not have sources of non-labour income or savings to support themselves if they do not work. Even where safety nets such as unemployment benefits are available (though they can be difficult to access), the personal and social costs of unemployment mean that many people may not see exiting unsatisfactory employment as a viable alternative.

• barriers that limit the mobility of labour between segments of the labour market. People can find it difficult to relocate to areas where jobs are more available, due to influences such as family circumstances, housing and ties to local communities and infrastructure. While developments such as long-distance commuting, temporary immigration, and advances in transport and communication technology have improved labour mobility in Australia, there are still significant personal reasons that hold employees to locations.

• employers that wield substantial purchasing power in the labour market (monopsonies). While monopsonies are historically associated with ‘one company towns’ where employees have little recourse to seek jobs nearby, they still persist in some sectors, for example government-provided services, or where the skills required by firms are sufficiently differentiated (sometimes referred to as monopsonistic competition). Behaviour to similar effect can also occur where employers in certain industries ‘cooperate’ to prevent wage bidding wars for talented employees.

These characteristics mean that in the absence of labour market regulations, wages are not necessarily set purely by reference to a competitive market rate, but rather through bilateral bargaining between employer and employee. The relative bargaining power of each party will determine their capacity to influence the final wage outcome.”

Unequal bargaining power

Given the PC’s acknowledgement of the significance of all these departures from the neoclassical model, it’s not surprising that the second of the two “enduring features of labour markets” it highlights in the “key points” of the report is that “without regulation and an ability to act collectively, many employees are likely to have much less bargaining power than employers, with adverse outcomes for their wages and conditions. Equally, poorly-designed regulation can risk bestowing too much power on organised labour in their dealings with individual employers. The challenge for a WR framework is to develop a coherent system that provides balanced bargaining power between the parties, that encourages employment, and that enhances economic efficiency. It is easy to both over and under regulate.”

In its appendix H on bargaining power, the report says “most [people] agree that the central goal of workplace relations policy is to reduce the superior bargaining power of employers over employees that would occur in the absence of regulation . . . 

• Bargaining power originates from the relative costs to contracting parties from failing to reach an agreement, with the result that one party can achieve leverage to re-distribute returns from the other.  For example, the cost of not employing a given employee may be low for the employer, while high for the employee.

• The neoclassical model of a perfectly competitive labour market predicts that imbalances in bargaining power cannot persist, with both employers and employees being ‘price takers’. However, there are a variety of factors that can differentiate the labour market (or at least many parts of it) from the perfectly competitive model, including: information asymmetries and search costs; a lack of voluntary entry and exit from the labour market; impediments to labour mobility; and employers with substantial purchasing power in the labour market (monopsonists).

• These factors mean that wages are generally set by employers and employees through bargaining, rather than purely by a competitive market rate. The resulting wage thus reflects relative differences in the bargaining power of parties.

• In the absence of regulation, imbalances in bargaining power would often be tilted towards employers, but in some circumstances may favour employees or unions.

• To counteract perceived inequalities in bargaining power, governments respond with policies such as enforcing minimum standards within the labour market (for example, minimum wages), and allowing employees to unionise and collectively bargain.

• A key regulatory concern is to ensure that in mitigating the risks of excessive employer bargaining power, regulations do not overcompensate by granting excessive power to employees.”

Minimum wage

 Which brings us to the minimum wage. The PC’s position is that “minimum wages are justified, and the view that existing levels are highly prejudicial to employment is not well founded. However, significant minimum wage increases pose a risk for employment, especially for more disadvantaged job seekers and in weakening labour markets”.

The report goes on to note (page 177) that:

“• Australia’s national minimum wage is high by international standards. It has risen in real terms over the last decade, although its growth rate has been constrained to reduce its ‘bite’ (the minimum wage as a share of median wages).

• There is an economic rationale for a regulated minimum wage that lifts the incomes of low-paid workers above the levels they would otherwise receive, to counter the effects of imbalances in bargaining power and other market distortions. There are also equity arguments . . . 

• At present, it is not possible to pinpoint the impacts of minimum wages on employment. Economic theory and some international empirical studies suggest that increases in minimum wages can reduce jobs and hours worked, but they also indicate that employment gains are possible in some circumstances. There have been few clear-cut wage ‘experiments’ in Australia and many studies are dated and/or have data and methodological limitations. The indirect evidence is also not clear-cut.

• While not definitive, the Productivity Commission’s assessment is that modest increases in Australia’s minimum wage are unlikely to measurably affect employment, but that large increases in minimum wages would reduce employment. How, and at what rate, such effects manifest will vary depending on economic conditions and other policy settings.”

If you’re not surprised by all that, you should be. At least until the publication of an empirical study by Card and Krueger in 1993, most economists were sure a “binding” minimum wage – one that held the wage rate above the level market forces would have set – would cause employment to be lower. This is what the neoclassical model predicted, and there was little reason to doubt it was true. Today, however, economists are strongly divided on the question, with many now doubting that modest increases in the minimum wage do much if anything to affect employment, while clearly benefiting those already on the wage. The Card and Krueger study compared changes in employment levels in the fast-food industry in adjoining states, New Jersey and Pennsylvania, when one state increased minimum wages and the other didn’t. It found that, if anything, employment rose a fraction after wages were increased. So this age-old question has now become an empirical rather than a than a theoretical question. Many more empirical studies have been done since Card and Krueger, and while many have confirmed its broader conclusion that minimum wage increases have little effect on employment, many have found that there remains a quite small negative effect.

Alternative models of the labour market

When labour economists realised how unsuited the neoclassical model was to analysing the workings of the labour market – and how off-beam its predictions could be, they began developing alternative models, ones with more realistic assumptions and thus more credible predictions. Trouble is, while most of these alternatives offer more believable explanations of some aspects of the labour market, none is sufficiently comprehensive as to allow it to be adopted as a replacement to the simple neoclassical model with its (often wrong) answer for everything. This is a big part of the reason the old model remains influential in many areas in addition to analysis of the labour market. I’ll run you quickly through a few of the lesser models before coming to the two I think are most useful, the efficiency wage and the oligopsony model.

Drawing on RG Castles little text, the dual labour market theory developed by the American economist Michael Piore argues that labour markets can be split into two distinct sectors, primary and secondary labour markets. The primary market consists of stable, relatively well-paid jobs, usually requiring both qualifications and skills. The company invests in training and seeks a long-term relationship with the employee. The secondary sector, by contrast, is characterised by poorly paid jobs with minimal training and high levels of staff turnover.

A related idea is the concept of “internal labour markets”. Most workers in the primary labour market are sheltered from the effects of changes in supply and demand in the labour market. Once they obtain a primary job, their future depends on the operation of an internal labour market within the firm. Firms have a long-term investment in their employees through on-the-job training and wish to encourage workers to remain with the firm. Management encourages productivity within a framework of long-term job security.

Efficiency wage. This term was first used by Marshall in the last edition of his text in 1924, by was developed in a different direction by Carl Shapiro and Joe Stiglitz in 1984. It argues that, at least in some markets, wages form in a way that doesn’t clear the market. It points to the incentive for managers to pay their employees more than the market-clearing wage so as to increase their productivity or efficiency, or to reduce costs arising from staff turnover. This greater efficiency justifies the higher wage. Even so, if wage rates are above the market-clearing level, unemployment is persistent. Shapiro and Stiglitz developed the case where, in markets where it’s difficult to measure the quantity and quality of a worker’s effort, there is an incentive for managers to pay a higher wage to discourage “shirking”, since workers have more to lose if they were sacked for shirking. A different rational motive for paying higher wages occurs where the high cost of training replacement workers means paying a higher wage to discourage staff turnover is justified. Or, if workers abilities differ, paying higher wages should help the firm recruit and retain more-able workers. George Akerlof’s version argues that higher wages encourage high morale, which raises productivity.

Oligopsony model. Monopsony means one buyer of a product or, in this case, labour. Oligopsony means just a few buyers – by no means uncommon in a modern economy where a few big companies dominate many product markets. As explained by Alison Booth, the oligopsony model assumes that even if workers have identical skills and abilities, they have differing preferences on which employer they want to work for, influenced by such things as how far the firm is from where they live, the hours they want to work, or whether they like the boss and their fellow workers.

 It takes time and effort (that is, cost) for workers to find alternative employers they like at least as much as their present one and, similarly, it’s expensive for employers to find a worker they like as much as the one they could lose. This makes many workers reluctant to change jobs and many bosses reluctant to change workers. And because these preferences are private information – the other side can’t be sure how strong there are – there’s scope for “economic rents”: for workers to be paid less, or more, than the value of their work. Less is more likely. Booth says the attraction of the oligopsony model is its ability to show how a minimum wage can actually increase employment, as well as why employers provide general training to workers who could leave and take the training with them.

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A terrible injustice most of us could face

It's one of the most glaring gaps between theory and practice in our community, a huge disconnect between our democracy and our economy. A terrible injustice most of us could face. Everyone knows about it, but it's rarely discussed. What is it?

The prohibitively high cost of justice. We're all supposed to be equal before the law, but you ain't anything like equal if they can afford a lawyer and you can't.

The president of the Law Council of Australia, Fiona McLeod, is running a campaign to highlight the plight of people who, in theory, should be receiving aid to help them with their legal problems but, in practice, often aren't.

People who include Indigenous Australians, those with disabilities, older people, children, the homeless and those experiencing economic disadvantage, prisoners and detainees, asylum seekers and other recent arrivals to Australia, people who have been trafficked and exploited, LGBTI people, those experiencing family violence and those in regional and remote areas.

The sad truth is that, in these times of tight budgets, when federal and state governments of both colours lack the courage to tackle the powerful interest groups benefiting from the biggest swathes of government spending, legal aid is treated as a soft touch.

You can chop it back without outcry.

But the problem is bigger than that. Lawyers speak of the "missing middle" – people who aren't rich enough to afford lawyers, but aren't poor enough to be eligible for legal aid.

That's some middle. In the Productivity Commission's 2014 report on access to justice, it estimated that only the bottom 8 per cent of households were likely to meet income and asset tests for legal aid, leaving "the majority of low and middle income-earners" likely to struggle or miss out.

To give you an idea, a less complex family law case costs the parties between $20,000 and $40,000, with complex cases costing more than $200,000.

And your chances of requiring legal help are higher than you may realise. A survey conducted in 2008 found that close to half of respondents experienced one or more civil (not criminal) legal problems, including family law matters, during a year.

The report says that "the ability of individuals to enforce their rights can have profound impacts on a person's wellbeing and quality of life.

"For example, it can mean that someone who has sustained injuries due to the negligence of others can seek recompense for impairment and/or their reduced income-generating capacity."

So what can we do to reduce this gap between what we're entitled to and what actually happens?

Short of nationalising the legal profession, there is no single, simple solution to the high level of lawyers' incomes and thus legal costs.

Apart from urging governments to spend more on legal aid, the Productivity Commission's answer is to chip away at the problem in as many places as possible.

More should be done to disseminate legal information (including self-help kits). States should establish a central, well-publicised point of contact for legal assistance and referral. The service would provide free telephone and web-based legal information, as well as actual advice on minor matters.

People need to be more aware of the ways to resolve disputes without using lawyers and courts. There are more than 70 government and industry ombudsmen and complaint bodies, covering telecom providers, banks and government agencies, which sort many matters with little cost or delay.

There are almost 60 federal and state tribunals, dealing mainly with challenges to bureaucratic decisions. The idea was that people would represent themselves and lawyers be avoided, but a legalistic approach is creeping in.

Then there's "alternative dispute resolution" where people such as retired judges can fix problems before matters get as far as court. More could be done to encourage this.

The courts have been doing more to manage their case load and push cases through, but they could do a lot more to reduce unnecessary cost and delay. They could make more use of technology to improve their performance.

The commission says there is "substantial scope to improve the efficiency and effectiveness of Australia's civil justice system" by curbing abuse of the adversarial system through a lack of co-operation and disclosure between the parties and the use of procedural tactics, and by discouraging disproportionate legal and other costs.

Rules about the awarding of costs could be toughened to discourage tactical delays and over-servicing.

As for the lawyers themselves, some of their longstanding rules of behaviour, supposedly intended to ensure clients get the best service, may be more about allowing them to charge more.

The commission says lawyer and client should be able to agree that the lawyer will do some, but not all, of the legal work involved.

It should be possible for more legal tasks to be performed by non-legal professionals.

It's permitted for lawyers to work on the basis that no fee is charged if a legal action is unsuccessful, but an extra percentage is added to the normal bill if it is successful.

But it's not permitted for lawyers to charge an agreed percentage of the damages their client receives. The commission believes that, with adequate protections, it should be.

If the courts and lawyers can't do more to limit the cost of legal proceedings, one day governments will get tough with them.

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Government losing its resistance to rent-seeking businesses

I'm starting to suspect the federal government – of whatever colour – has lost its ability to control its own spending.

Even if this is, as yet, only partly true, governments are likely to have unending trouble returning the recurrent budget to balance and keeping it there, let alone getting it into surplus so as to pay down debt.

Those of us who worry about such things have given too little thought to the causes of the Abbott-Turnbull government's abject failure to achieve its oft-stated goal of repairing the budget solely by cutting government spending.

It's common to blame this on political failure and obstacles. There's truth in most of those excuses, but they miss the point. Spending restraint will never be easy politically, governments rarely have the number in the Senate and their opponents will always be opportunistic.

That's why governments need to be a lot clearer about what they're seeking to achieve on the spending side, and a lot more strategic in how they try to bring it about.

On ultimate objectives, the goal of literally smaller government – smaller than it is today – is a pipedream. Government spending is almost certain to rise over time – don't you read Treasury's intergenerational reports? – meaning taxes will have to rise over time.

But there are obvious limits to voters' appetite for higher taxes, which is why governments need to be able to control the rate at which their spending is growing, and do it not by cost-shifting to other governments or service recipients – as was the approach in the failed 2014 budget – but by ensuring ever-improving value for money through greater efficiency and effectiveness.

Unless governments lose their obsession with welfare spending (most of which goes to the aged) and come to terms with the other two really big items of government spending, health and education – especially when you consolidate federal and state budgets – they won't get far with controlling the rate of growth in their spending.

What too few people realise is how much of government spending goes not directly into the pockets of voting punters, but indirectly via businesses big and small: medical specialists, chemists, drug companies, private health funds, private schools, universities fixated by their ranking on global league tables, businesses chasing every subsidy they can get, not to mention international arms suppliers.

The budget, in other words, is positively crawling with vested interests lobbying to protect and increase their cut of taxpayers' money.

A government that can't control all this potential business rent-seeking – isn't perpetually demanding better value for taxpayers; perpetually testing for effectiveness – is unlikely to have much success in limiting the growth in its spending.

Which brings me to my fear that government has already lost that ability.

A wrong turn taken early in the term of the Howard government – when the Finance department moved most responsibility for spending control to individual departments and got rid of most of its own experts on particular spending areas – plus many years of "efficiency dividends" (these days a euphemism for annual redundancy rounds) have hollowed out the public service.

The spending departments have lost much of their ability to advise on policy, while the "co-ordinating departments" – Treasury, Finance and Prime Minister's – have lost much of their understanding of the specifics of major spending programs.

This matters not just because the departments have become increasingly dependent on outside consultants to tell them how to do their job – and to be the for-profit repositories of what was formerly government expertise – which could easily be more expensive than paying your own people.

The big four chartered accounting firms were paid $1 billion in consulting fees over the past three years, thus introducing a whole new stratum of potential rent-seeking.

More importantly, the longstanding practice of having specialised departments – one each for the farmers, miners, manufacturers, greenies etc – makes them hugely susceptible to being "captured" by the industry they're supposed to be regulating in the public interest.

The departments soon realise their job is to keep the miners or whoever happy and not making trouble for the government.

The Health department, for instance, would see its primary task as dividing the taxpayers' lolly between the doctors, the chemists, the drug companies and the health funds in a way that keeps political friction to a minimum.

How much incentive do you reckon this gives the spending departments to limit their spending, root out rent-seeking and lift effectiveness?

That's why, by denuding the co-ordinating departments of people who know where the bodies are buried in department X, government has lost a key competency: the ability to control the growth in its own spending.

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