Competition isn't always as good as we're told

The banking royal commission has many sub-plots. Did you notice the one where a couple of the banks blamed their decisions to keep doing things they knew were dodgy on the pressure of competition?

A chap from Westpac didn’t argue when one of the inquiry’s barristers criticised it for paying “flex commissions” to car dealers arranging loans for people buying cars. The higher the interest rate the dealers could get their customers to accept, the higher the (undisclosed) commission Westpac paid them.

The Australian Securities and Investments Commission has decided to prohibit this practice from November. So why was Westpac persisting with it until then? Because, if it simply stopped doing it off its own bat, it would lose most of its business to competitors.

Another chap, from the Commonwealth Bank, gave a similar explanation for it continuing to base its commissions to mortgage brokers on the size of the loans they organised. If it stopped doing the wrong thing, he said, its brokers would switch to dealing with other banks.

But since it’s a relaxing long weekend, let’s not persist with such a blood-pressure raising subject as the behaviour of our lovely banks. No, let’s just have a calming philosophical discussion about the complications of competition in markets.

Economists like to give us the impression competition is a fabulous thing in any market, all upside and no downside. Competition is something you can never have enough of, they imply.

Don’t believe it. It’s certainly true that a market with no competition – a monopoly – isn’t a great place. Prices are high, service is bad, and when you complain to the company, no one gives a rat’s.

But it doesn’t follow that all competition is wonderful, nor that more is always better. Far from it.

The simple “neo-classical” model of markets assumes a large number of small sellers. The competition between them is so fierce that none of them dares charge a price that’s a cent more than the minimum needed to cover their costs (including the cost of the capital invested in the business, aka profit).

All sellers charge the same price, and if you try selling for a bit more, you sell nothing and go bankrupt.

In the real world, it ain’t so simple. There are various reasons for this, but a big one is the presence of economies of scale – the more you produce, the lower the average cost of what you’re producing.

This allows you to lower your price – which is good for buyers – but, as a consequence, sell a lot more, which is also good for you.

It’s scale economies that explain why so many of our real-world markets are the opposite of what textbooks assume: a small number of large sellers – known as oligopoly. The big four banks are a good example.

When you look at the behaviour of oligopolies you see competition isn’t as wonderful as it’s cracked up to be. Oligopolists compete fiercely against each other, but they compete mainly for market share, and try to avoid competing on price.

According to the economists’ basic model, however, low prices are the key benefit competition brings us. In reality, oligopolists prefer to keep prices and profit margins high by competing via marketing and advertising, including by “differentiating” their products.

Occasionally a firm tries to steal a march on its competitors by innovation – coming up with a product that’s clearly better than the others. Mainly, however, product differentiation involves superficial differences.

Economists preach the virtues of competition because they assume it gives consumers a wider range of products to choose from, which must be a good thing.

But with only a few sellers, competition tends to do the reverse, limiting the choice available. Each firm will have a product range remarkably similar to the others.

This is because the few big firms focus on each other, not the customers. Their goal is not so much to find the magic product the punters will love, as to make sure their competitors don’t get ahead of them. So product ranges tend to be the same.

But how do we explain those two bankers claiming competition prevented them from ceasing dodgy practices? Why wouldn’t a bank want to get itself a reputation for being square with its customers?

Because of another weakness in the economists’ basic model: its assumption that both buyers and sellers know all they need to know about market conditions - an implicit assumption that gaining the knowledge you need to make good choices is easy and costless.

In reality, it costs time and money to be well-informed, which gives sellers (who tend always to be in the market) an inbuilt advantage over buyers, who tend to buy a new car, or change houses, only occasionally.

The first economists to starting thinking such thoughts just a few decades ago ended up winning Nobel prizes for realising that information is “asymmetric”, with sellers usually knowing a lot more than buyers.

In the two cases from the royal commission, the banks and their car dealers and mortgage brokers know about the conflicts of interest caused by their commission arrangements, but customers don’t.

Should one bank decide to stop playing that game, many of its dealers or brokers would have taken their business elsewhere long before the nation’s customers realised it was more trustworthy than its competitors.

Up-to-date economists see this as a class of “market failure” called a “collective action problem”: all the firms in a market realise they’re doing something wrong, or even profit-reducing, but no one’s game to be the first to stop.

The obvious solution is for the government to intervene and ban the practice, letting everyone off the hook at the same time - just as ASIC has decided to do in the case of flex commissions for car dealers. Sometimes competition needs help from a visible hand.

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Cheating cricketers symptomatic of our declining standards

I can’t see why people are so shocked to discover our cricketers have been cheating. Surely that’s only to be expected in a nation that’s drifted so far from our earlier commitment to decency, mateship and the fair go.

Such behaviour is unAustralian? We do, or condone, many things that used to be thought of as unAustralian.

There was a time when it would have been unthinkable for Australians to stand by while an elected government physically and psychologically mistreated people whose only crime was to arrive by boat without an invite.

Many of them are fleeing persecution in their own country, but that makes no difference. We even mistreat their children, causing them to have mental illnesses and then refusing them medical treatment.

Last week a government led by Mr Harbourside Mansion dished out another round of punishment to fellow Australians whose crime was to be unemployed or to have split with their partner while having dependent children, making it hard for them to do paid work.

The money to be saved will go just the tiniest way towards paying for tax cuts for big business. Did the rest of us care? Not really.

But let’s not kid ourselves. If governments thought mistreating asylum seekers and being unreasonable to welfare recipients would lose them votes, they wouldn’t do it.

They do it because they believe most voters want them to punish boat people and supposed dole bludgers. Which also explains why both sides of politics are guilty of it.

Lovely people, Australians. (And don’t imagine the rest of the world isn’t realising how unlovely we are.)

But stoop to tampering with a cricket ball? We’d never do something so utterly despicable. A player could have been injured.

Don’t forget that cricketers have money at stake when they decide whether to ease the path to victory with the help of a little sticky tape.

Nor should we imagine they’re the only Aussies yielding to the temptation to bend the rules in pursuit of a bigger bonus. What do you think the royal commission into banking misconduct is about?

I fear we hear about only a fraction of the national franchises that screw their franchisees, who then screw the kids working for them; the many employers paying less than award wages, including those ripping off people on temporary work visas who’re afraid to complain.

They do so because they’ve lost any sense of fairness towards their workers – and because they’re (rightly) confident their chances of being caught are low.

Governments – Coalition and Labor - have been cutting the number of inspectors and auditors in the name of greater public service efficiency.

We’ve become less Godfearing, more individualistic, more materialistic and more self-centred. We’ve become less community-minded, less committed to “solidarity” – where the strong go easy so as to help the weak do better – and less sympathetic to the battling of the battlers (except when we kid ourselves that we are battlers).

We’ve changed the meaning of “professional” to being highly competent in your occupation, whereas it used to mean putting your clients’ interests ahead of your own.

Politics has degenerated into an unending battle between interest groups, in which each seeks advantage at the expense of the rest. Much of the fighting is conducted by a thriving industry of lobbyists.

Even the churches fight like Kilkenny cats for a bigger share of the government handouts to private schools – just so they can afford to teach their children Christian values, of course.

But don’t imagine the greed is limited to businesses and institutions. Almost all of us have a mercenary attitude towards the government, paying as little tax as possible while demanding free public hospitals, subsidised pharmaceuticals, bulk-billed GP visits and much else.

How does all that add up? Not my problem. My problem is paying an investment adviser to tell me the somersaults I have to turn to get the pension and avoid paying tax on my investments.

What I’ve found most surprising in recent days is not money-hungry cricketers but the views of a leading businessman, Harold Mitchell, expressed in this very organ: “I’m an Australian and I pay tax for the good of the country.”

Mitchell tells of being visited by representatives of the Singapore government, who invited him to move his head office there. Their advertised company tax rate was 15 per cent, but he’d get a special offer of 7 per cent.

He declined. “I believe in the Australian system that creates the sort of society that enabled me to build a successful business. Avoiding tax, even if it seems legal, is a very shortsighted ambition,” he wrote.

What’s wrong with the man? What a corporate dinosaur. He claims to have found at least one other rich person who thinks similarly – the Scottish children’s author, JK Rowling.

“I pay a lot of tax, and I feel one of the reasons I stay and pay and why I’m not based in Monaco ... is I think my country helped me,” she's said.

Mitchell even quoted the American jurist Oliver Wendell Holmes’ dictum that “taxes are what we pay for a civilised society”.

Perhaps the problem is it also works the other way: more money-grubbing, rule-bending and tax avoiding are part of a society that’s becoming less civilised.

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We have a bad case of misdirected compassion

Why do so many of us – and the media, which so often merely reflect back the opinions of their audience – feel sorrier for those who profess to be poor than for those who really are?

Last week, on the day after the single dole was increased by 50¢ to a luxurious $273 a week ($14,190 a year), Malcolm Turnbull’s henchmen succeeded in persuading Pauline Hanson’s One Nation to let him give the down-and-out part of our one nation another kicking. (Sorry, my Salvo upbringing is showing again.)

You’ve heard the news that homelessness is much more prevalent than we thought. According to the Australian Council of Social Service, the Senate’s passing of the Orwellian Welfare "Reform" Bill will, in its first year, add to homelessness by cutting off payments to more than 80,000 people.

The bill contains 17 measures that will adversely affect the lives of thousands of the unemployed, single parents and women and children escaping violence.

You’ve never seen such a list of pettifogging nastiness, yielding tiny savings to the budget.

The unemployed will no longer be back-paid to the day they lodged their claim, meaning the longer Centrelink takes to process that claim, the longer the jobless go without (or have to go cap-in-hand to outfits like the Salvos) and the more pennies the government saves.

Let’s hope it doesn’t make lengthening processing times a KPI.

Until now, the legislation has protected people who can’t complete and lodge their claim because they’re in hospital, are homeless, are escaping domestic violence, or are victims of natural disaster or fire. Sorry, such pathetic excuses will no longer be accepted.

Fortunately, Hanson was shamed into reneging on a commitment to remove a small, one-off “bereavement allowance”.

So, were the media up in arms over this gratuitous attack on people who are already below the poverty line – this “cash grab”?

No, they hardly seemed to notice. Perhaps they were distracted by the bitter tears they were shedding over the plight of all those poor self-funded retirees whose unused dividend imputation refunds the evil Labor Party is threatening to steal.

I’m sure there must be a few retireds with genuine cause for complaint, but I didn’t see any among those whose cries of pain were taken up by a righteously outraged media.

Perhaps the problem is that most political reporters are too young to know how retirement income works. Let’s look at Australia’s most self-pitying and grasping group, the self-proclaimed “self-funded retirees”.

What they mean by this term is that they don’t get the age pension. What they fail to mention to naive reporters is that they don’t get it because they’re too well-off to meet the means test – notwithstanding the best efforts of their investment advisers to rearrange their affairs so they do.

What’s the main reason they’re too well-off to get the age pension? Too much superannuation savings. That’s why I see red every time I hear them claiming to be “self-funded”.

They’ve convinced themselves they’re fiscal heroes who are saving the government a fortune by not getting the pension. Rather, they’ve scrimped and sacrificed for decades to amass the super savings they have.

But they’re deluding themselves on both counts. They conveniently forget that their contributions to super were taxed at 15 per cent rather than their much higher marginal tax rate, as were the annual earnings on those tax-concession-enhanced contributions.

And, since 2007, thanks to Peter Costello (who spent his time as treasurer planting time-bombs in the budget), they’ve paid no tax on their super withdrawals.

As a result, a proportion of their super balance is attributable not to their frugality, but to decades of annual tax concessions, plus compound interest on those concessions.

The higher the payout, the higher the proportion of it attributable to tax breaks rather than actual saving. For most of those with super balances high enough to exclude them from the pension, those accumulated tax breaks would greatly exceed the budgetary cost of that pension, sometimes several times over (as in my case).

That’s being “self-funded”?

Another thing the media’s bleeding hearts (middle-class division) don’t know is that since withdrawals from super are tax-exempt, the money that allegedly self-funded retirees have to live on far exceeds the modest “taxable income” they tell you about.

When they cry poor, these comfortably-off people with their hand out don’t tell you their goal is to get sufficient assistance from the taxpayer to allow them to avoid dipping into the capital value of the shares and property they want to hand on intact to their offspring – who are, no doubt, just as deserving as they are.

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Economic case for cutting company tax rate is weak

Most people don't realise it, but we're on the verge of letting foreign multinationals pay less tax on the profits they earn in Australia because we locals don't mind paying higher tax to make up the difference.

Our almost unique system of "imputing" to Australian shareholders the company tax already paid on their dividends means they have little to gain from Malcolm Turnbull's pressure on the Senate to phase the rate of company tax down from 30 per cent to 25 per cent, over about 10 years, at a cumulative cost to the budget of $65 billion.

So what can we hope to obtain in return for our generosity to foreign businesses? Economic theory (which may or may not prove realistic) assumes it would induce them to increase their investment in Australia which, in turn, would increase the demand for Australian workers relative to their supply, thus bidding up their price (otherwise known as wages).

Note that, contrary to all Turnbull's said about his "plan for jobs and growth", the theory does not promise a significant increase in employment – mainly because the theory assumes the economy is already at full employment before the company tax rate is cut.

As my colleague Peter Martin has written, Treasury's updating of its modelling of the theory finds that, after 10 to 20 years, consumer welfare (arising mainly from higher wages) would be $150 per person higher than it otherwise would be.

Doesn't seem a lot.

Apart from the initial benefits of the company tax cut going pretty much only to foreigners, another reason Treasury's modelling has always shown the ultimate benefits to us as being surprisingly small is Treasury's further assumption that the budgetary cost of the cut would have to be covered by some means.

Treasury's consultant modelled several possibilities: by cutting government spending (don't hold your breath), imposing a lump-sum tax (a textbook fav), increasing the goods and services tax, or by letting bracket creep quietly increase income tax (the most likely).

Trouble is, the model's assumption that increased taxes would harm the economy's performance diminishes the good the lower company tax is assumed to do. As Milton Friedman liked to say, there are no free lunches (you'll end up having to pay, one way or another).

So the impression the government and big business are trying to give us (and naive crossbench senators), that only an economic wrecker would oppose a lower company tax rate, is just spin.

As always, every possible economic policy change has costs as well as benefits, which should be debated. I think the case for cutting company tax is weak.

With the government taking such a propagandist line, the most dispassionate advice we've received has come from evidence Reserve Bank governor Dr Philip Lowe, and an assistant governor, Dr Luci Ellis, gave to a parliamentary committee last year.

Lowe pointed out something no other official has mentioned: the main countries are engaged in a bidding war, in which each moves to a lower company tax rate than the others, hoping to pick up a bigger share of the world's foreign investment - before some other country cuts to an even lower rate.

You can imagine how much the world's chief executives love this game and are urging their own government to put in the lowest, supposedly winning, bid.

But the longer everyone keeps playing, the closer we'll come to the point where no country has any company tax to speak of – and no country has any competitive advantage over the others. All we'll be left with is a distorted tax system.

Lowe's point was that we should think twice before we join this mutually destructive game. Why would a tax war be good, whereas a trade war would be terrible?

The proponents' latest argument is that, now the US is cutting its company tax rate to 21 per cent, we'll get little foreign investment if we don't cut our rate from 30 per cent.

What no one seems to have noticed is that the case for a company tax cut has now turned from positive to negative. It's not that we'll gain anything by cutting, but just that we'll avoid losing if we don't.

But you don't have to accept that argument if you don't want to. Behavioural economics reminds us that the proponents have "framed" our choices in a way that favours their case.

They want us to accept without thinking that foreign companies make their decisions about whether or not to invest in Oz solely by comparing the rate of our company tax with other countries' rates.

That is, foreigners take no account of how our special tax breaks compare with other countries' tax breaks, nor any non-tax factors that make investing in Oz attractive (say, we've got better iron ore than everyone else) nor even that they don't have to worry about our taxes because their lawyers know how to avoid paying them.

As Lowe and Ellis explained to the parliamentary committee, the notion that multinationals focus solely on the rate of our tax is highly implausible.

I think all those other factors mean we're unlikely to attract insufficient foreign investment, even though the US has cut to 21 per cent.

But Treasury's been a great worrier about us attracting enough foreign investment for as long as I've been in the game, without there ever being much sign of a problem.

So, what's eating Treasury? My theory is that it hasn't adjusted its thinking since we moved from a fixed to a floating exchange rate in 1983.

What the proponents of a lower company tax rate don't tell you is that, with a floating dollar (and all else remaining equal), the more successful we are in attracting foreign investment – as we were in the resources boom - the higher our exchange rate will be. Is that what we want?

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How Labor is taking on the greedy elderly

Talk about missing the point. The media spent all last week working themselves into a lather over Labor's newly announced policy to abolish cash refunds for unused dividend imputation credits. (If you have no idea what that means, it probably wouldn't affect you.)

This promise would be terribly unfair to dirt-poor self-funded retirees, we were told. And it was utter stupidity for Bill Shorten to drop such a monumentally unpopular proposal in the last week of the Batman byelection, which he was now safe to lose.

Except, of course, that Labor won comfortably, with little sign the policy had much effect.

The media smarties' greater failure was their inability to see the bigger picture: the next federal election is shaping as a battle between the generations, with Labor championing the put-upon young and the Coalition defending the privileged old.

According to Canberra conventional wisdom, this too is crazy-brave territory for Labor. The ageing of the population means Grey Power is our fastest growing political force.

Those of retirement age (which includes me) have little more pressing to do than to worry incessantly about their finances, and have developed an unshakable sense of entitlement ("I've paid taxes all my life ..."). Any concession they've been granted, no matter how unjustified or unaffordable, can't be taken back, we're assured.

Well, I'm not so sure.

As a political force, Grey Power has one huge weakness: of all the age groups, the over-65s are those least likely to change their vote. The great majority vote for the Coalition, so Labor doesn't have a lot to lose.

It's among the non-aged (sorry) that most swinging voters are found, and it's by picking up enough swingers that a party wins.

Haven't you noticed how, since 2013, the Coalition has been reacting to Labor's pro-younger policies by flying to the defence of the better-off old? The conservatives are allowing themselves to be "wedged" – separated from the majority of voters.

The Canberra smarties also used to believe negative gearing was politically untouchable. But Labor went to the 2016 election promising to curtail it – while the Libs predicted it would send house prices crashing – and came within a whisker of winning. Labor's persisting with the policy.

Labor went to that election with another pro-younger policy: cutting the tax breaks going to exceptionally well-off superannuants (including me). This time, Malcolm Turnbull, needing help to pay for his company tax cuts, produced his own, Treasury-crafted version of Labor's idea.

The issue didn't feature greatly in the election campaign, but after the Coalition had won, the exceptionally well-off superannuants in the Liberal heartland turned on Turnbull. This advantaged Labor by adding to the disunity in the Coalition's ranks. Turnbull modified his super changes, but not greatly.

And now Labor is planning to remove another super tax concession that goes overwhelmingly, but not exclusively, to superannuants with large share portfolios. The Coalition hasn't resisted the temptation to side with its well-off elderly heartland, nor have the media resisted the temptation to promote its (and the super industry's) misrepresentation of the policy as an attack on struggling retirees (who just happen to own a lot of shares).

How is this another of Labor's pro-younger policies? That will be easier seen if, as seems likely, Labor uses the saving to pay for a promise of income tax cuts for people earning less than $87,000 a year – few of which would go to the retired rather than to the workers who pay for the retired's largely income tax-free status.

If you think an election campaign based on conflict between the generations is not a good thing, I agree. Unless what you mean by that is that the better-off aged should be allowed to retain their relatively recently conferred tax advantages, and the taxpaying non-old should continue to lump it.

It's a pity John Howard and Peter Costello (the chap who kept issuing reports warning that population ageing would play merry hell with the budget) didn't worry more about future generational conflict when they spent most of their 11 years in office slipping new benefits for the aged, particularly self-funded retirees, into the budget.

They started with the private health insurance tax rebate (the biggest users of private health insurance services are 60 to 79-year olds) and moved on to giving the alleged self-funded retirees the "seniors and pensioners tax offset", also making it easier for them to get health cards and pay the pensioners' rate for pharmaceuticals.

In 1999, they gave negative gearing a huge boost by introducing a 50 per cent discount on capital gains tax. And they decided that anyone who paid so little income tax they couldn't take full advantage of their dividend imputation credits should be sent a refund for the balance.

On the younger side of the ledger, while they didn't invent HECS debts for university students, they greatly increased them.

Then, in 2007, Costello introduced sweeping super changes, making super payouts completely tax-free for people over 60. He also made a lot of supposedly self-funded people eligible for a part pension.

Since this largesse was quite unaffordable, Labor and Coalition governments have been chipping it back ever since.

Even so, we retain an income tax system where how much you pay sometimes depends on the size of your income, but other times on how old you are. And that's not going to lead to intergenerational conflict?

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