How politics came to trump economics in Canberra

How does the federal government really work? Is it as we were told in Yes, Minister, with the bureaucrats actually in charge, quietly manipulating the politicians? Or are public servants actually the servants of their political masters, as the pollies focus more on getting re-elected than running the country well?

Does Treasury dominate the other departments and the economic advice going to government? Do bureaucrats still give ministers "frank and fearless" advice, or has their role been usurped by the ever-growing army of ministerial staffers, politically aligned think tanks and lobby groups?

In truth, it’s hard for outsiders to be sure. But a new book by a former 30-year senior Treasury officer, Paul Tilley, Changing Fortunes, is surprisingly frank and fearless in spelling out how things work, and how Treasury’s relationship with the elected government has "changed dramatically in recent times".

Last month Scott Morrison said he saw the bureaucrats’ role as implementing the government’s policies. Their advisory role was limited to advising the government of any problems that might arise during that implementation.

Tilley makes it clear this isn’t just what Morrison would like, it’s pretty much what he and his recent predecessors have long had. Treasury gives much information to the treasurer, but avoids giving written policy advice it believes would be unwelcome. What little frank advice is given comes verbally, as part of the private discussion between the treasurer and Treasury secretary.

Tilley says the art of policy advising involves understanding the true nature of the problem, predicting the consequences of policy options and framing effective policy advice.

To be influential, however, policy advisers need to find a balance between having sufficient separation from the raw politics of government to maintain a strong policy framework, on one hand, and having sufficient responsiveness to ministers to be listened to, on the other.

"Treasury’s influence spectrum had ‘frank and fearless advice’ at one end and full ‘responsiveness to government’ at the other," he writes. The trick was the find the right spot in the middle.

But by 2014, under Tony Abbott, "Treasury was now at the full responsiveness-to-government extreme," he writes.

His book is a history of Treasury from its establishment in 1901. "Treasury has long considered itself to be the best economic policy advising agency in Australia.

"Its favoured economic policy framework has for the most part been grounded in neoclassical economics - a belief in the power of markets, and the inherent tendency of supply and demand forces to move towards equilibrium.

"Non-achievement of equilibrium must be caused then, by some market impediment or government interference, and Treasury has seen it as its job to tackle those impediments or that interference.

"If there has been one enduring belief within Treasury – its light on the hill – this is it," he writes.

This is what Tilley means by Treasury’s possession – unlike so many other departments - of a "strong policy framework".

"If there has been a central defining culture in Treasury, it has been around analytical excellence – having the strongest policy framework and the best ideas. If there has been one recurring constraint on Treasury’s policy effectiveness, it has been too narrow in its focus and closed to alternative perspectives," he says.

Tilley’s title, Changing Fortunes, recognises that, over its 118-year life, Treasury’s influence has waxed and waned.

For its first 30 years it was the government’s bookkeeper. It evolved into an economic policy agency only after the Great Depression revealed its inability to provide authoritative advice on economic policy.

The economists arrived from the 1930s, with the advent of Keynesianism. The "golden years" for the economy in the 1950s and ‘60s were also golden for Treasury, which grew in size and status, leading the debate about economic ideas and allowing its influence and strength to give it "a level of arrogance".

This did not sit comfortably with the increasingly assertive governments of the post-Menzies era. Treasury was pushed out into the cold by Gough Whitlam, and kept there by Malcolm Fraser. Treasury’s advice remained frank and fearless, but was considered dogmatic, and often wasn’t listened to. I think this was when our Yes, Minister era ended.

Relations became more constructive when Bob Hawke and Paul Keating arrived, and continued so under John Howard and Peter Costello. "There was a sense of partnership in the Treasury-government relationships, and with the advancement of economic reforms that Treasury advocated it again influenced the policy agenda."

But for the past decade, first under the Rudd-Gillard-Rudd government, then under Abbott-Turnbull-Morrison, the "political chaos" has robbed governments of the sustained political capital needed to pursue difficult reforms. Governments fighting for their political survival have maintained a "relentless push for message over substance".

"In the daily political and media battles of the last decade, Treasury policy advice has not been sought, and at times not very effectively given. In those battles, it has been economic and budget facts and figures, not policy advice, that have been demanded," we’re told.

"The habit has developed of not providing policy advice that ministers don’t agree with. Policy advice on contentious issues now is discussed with ministers’ offices in its preparation and if the office indicates that the minister would not be comfortable with the proposed advice an information brief goes instead.

"The office’s (politically attuned) policy advice can then be provided over the top of the Treasury information brief."

The balance of policy influence has shifted to the political offices and external stakeholder groups, with the public service becoming more information providers and implementers of government decisions, he says.

"The government, therefore, is left without a strong source of genuine policy advice. The consequent lack of a consistent economic narrative over the last decade is plain for all to see."

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One day the world's population will start falling

For those who worry about global warming and all the other damage humans are doing to our planet, the latest news on world population growth doesn’t seem good. Fortunately, however, the relationship between population and the environment is paradoxical.

The United Nations Population Division updated its projections in June. From its present 7.7 billion, the world’s population is projected to have grown by 2 billion in 2050. It should reach a peak of nearly 11 billion at about the end of this century, before it starts to fall.

Fortunately, projections are just projections, based on a lot of assumptions that may or may not prove to have been accurate. Some prominent demographers believe the UN’s assumptions are too pessimistic.

It’s a mistake to imagine that controlling world population growth is just a matter of access to effective contraception. Economic development also plays a big part.

It’s the activity of humans that generates greenhouse gas emissions and does other damage to the natural environment, using up non-renewable resources, over-using renewable resources such as fish stocks and forests, damaging soil and waterways, and making species extinct.

So the more people, the more damage. Most human activity is economic – people earning their living. And, the way economies are organised at present, the richer people become, the more damage they do.

But here’s the paradox: the richer people become, the fewer children they have.

As my favourite magazine, The Economist, noted in an article, before the Industrial Revolution the typical woman probably had seven or more children. In 1960, the global fertility rate was six children per woman. Today it’s 2.5.

Within that global average, the fertility rate in rich countries is 1.7 children, below the replacement rate for a stable population of 2.1. In middle-income countries it’s 2.4, not far above replacement. In poor countries, however, it’s 4.9 children.

The first economic factor to reduce family size is urbanisation. When you leave the farm, you don’t need as many kids to help with the work. (Both my parents grew up on farms early last century. Dad was one of 14, and Mum one of eight. Their four children, however, had an average fertility rate of 2.5.)

But perhaps the most important factor is the spread of education, particularly of girls. It’s well established that the more years girls spend at school, the fewer babies they have.

“Education reduces fertility by giving women other options,” The Economist says. “It increases their chances of finding paid work. It reduces their economic dependence on their husbands, making it easier to refuse to have more children even if he wants them.

“It equips them with the mental tools and self-confidence to question traditional norms, such as having as many children as possible. It makes it more likely they will understand, and use, contraception.

“It transforms their ambitions for their own children – and thus the number than they choose to have.”

Worldwide, the proportion of girls completing primary school has risen from 76 per cent in 1997 to 90 per cent today. The proportion completing lower secondary school is nearing 80 per cent.

Fertility rates are low in Europe – particularly in Italy (1.33) – and in Japan (1.37). They’re below replacement rate in New Zealand (1.9), Australia (1.83) and the US (1.78).

But the lowest fertility rates are in emerging Asia: Taiwan (1.15) and South Korea (1.11). In the world’s most populous country, China, it’s 1.69, thanks to the one-child policy. After the relaxation of that policy it rose only briefly. Flats are too small and childcare too limited.

By contrast, India’s rate is 2.24, pretty close to replacement. And it varies greatly from 1.8 in wealthy states such as Maharashtra, to more than 3 in poor states such as Uttar Pradesh. Even so, India's population is expected to overtake China’s in 2027.

Because fertility rates cover the whole child-bearing lives of women, it takes a long time for the population of a country that's a bit below the replacement rate to start falling – assuming they don’t top up with immigration, as we do.

Even so, 27 countries’ populations have fallen since 2010 – sometimes with low fertility rates reinforced by high emigration. Over the next 30 years, 55 countries’ populations are projected to fall – almost half of them by more than 10 per cent. China’s may fall by about 31 million, or 2 per cent.

So what’s the problem? In a word: Africa. Its painfully slow rate of economic development leaves it still with fertility rates of five or six, including big countries such as Nigeria, the Congo, Ethiopia and Tanzania.

The best hope that the world’s population will stop growing sooner than the UN projects is that it has underestimated the rise of girls’ education in Africa (and India and Pakistan).

Of course, economic development is two-edged. It may stop population growth, but it makes everyone else richer and thus makes more demands on the environment.

Just as we can limit climate change without reducing energy use by switching to renewable sources, so we could reorganise the economy in ways that ensured continued economic growth didn’t involve continued destruction of the environment. If we had the will.

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Are low interest rates bad? It depends on your perspective

Although media coverage invariably assumes that low interest rates are good news, they’re now so low there’s a backlash, with people pointing to the disadvantages of low rates and getting quite worried.

The fightback is coming at the usual level of complaints from the retired, but also from more sophisticated observers, such as Andrew Ticehurst, of the Nomura banking group, and Dr Stephen Grenville, a former deputy governor of the Reserve Bank.

It’s understandable that the retired and other savers object to the Reserve Bank’s decisions to cut interest rates and are particularly exercised now rates are so close to zero. Doesn’t the Reserve understand we live on our interest income? Of course it does. So why does it persist?

Interest rates are the price borrowers pay lenders (and, ultimately, savers) for the use of their money for a period. Clearly, cutting rates benefits borrowers at the expense of savers. Central banks cut rates to encourage borrowing and spending because they know the expansionary effect on borrowers greatly exceeds the contractionary effect on savers.

They’ll never be dissuaded from this approach. It’s true interest rates are a “blunt instrument”, but they’re pretty much the only instrument central bankers have.

The retired are on much stronger ground when they insist the government continually updates the “deeming rates” it uses to assess the effect of people’s savings on the amount of their part-pension. It’s surprising the grey lobby has taken so long to wake up to this.

The more sophisticated criticism is that, though market economies thrive on risk-taking (and this is one of the mechanisms by which lower rates are expected to stimulate demand), unduly low rates encourage excessive risk-taking.

Businesses are encouraged to become dangerously highly “geared” or “leveraged” (too dependent on borrowed capital rather than share capital) and firms invest in projects that are high-risk or are profitable only if the cost of borrowing is unrealistically low.

In both cases, the seeds of the next bust are being sown. When rates go back up, firms and projects will fall over and there’ll be hell to pay. Very low rates also allow the survival of “zombie” firms – those that have failed and should have died, but are still living – which tie up resources that could be used more efficiently elsewhere.

Running “ultra-loose monetary policy” at a time when demand is weak can do more to cause dangerous bubbles in share, property and other asset markets than to stimulate markets for goods and services.

There’s merit in these arguments – in normal times. But this brings us to the key question of our times: are our present troubles cyclical or structural? Is it just taking frustratingly long for the economy to return to the old normal, healthy rate of growth, or have so many major (but, as yet, not fully understood) changes occurred in the structure of the economy that a “new normal” has arrived, requiring us to get used to a much lower rate of growth, complete with permanently lower inflation and interest rates?

Treasury is sticking firmly to the view that we’ll soon return to the old normal (thus adding weight to the critics’ worries about the bad seeds being sown by protracted low interest rates) and so is the Reserve – except that governor Philip Lowe’s recent exposition of the reasons for persistent low inflation had a bob each way, nominating cyclical (spare capacity) and structural (effects of digitisation and globalisation) factors.

Remember, interest rates come in two parts: the borrower’s compensation to the lender for the loss of their money’s purchasing power while it’s in the borrower’s hands (the expected inflation rate) plus the borrower’s payment to the lender for the use of their money during the loan (the “real” interest rate).

For as long as inflation stays low, nominal interest rates will stay low – without any real loss to savers, even though their susceptibility to “money illusion” (forgetting to allow for inflation) means many don’t realise it.

And here’s something many people haven’t realised: globally, real interest rates have been falling since the 1970s and are still falling. Harvard’s Lawrence Summers finds in a recent paper that real rates have declined by at least 3 percentage points over the past generation.

Put the two parts together and interest rates – both nominal and real – look like staying low for a long time, whether we like it or not. This says many formerly unprofitable investment projects are now profitable, and budget deficits and high public debt are now much less worrying.

The critics imply the Reserve has great freedom to keep the official interest rate high or low. Not really. It can’t defy economic gravity. It’s the Morrison government that could, at the margin, use its budget to reduce the pressure on the Reserve to cut rates further.

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Star pupil Philip Lowe gives tips on why inflation is so low

Reserve Bank governor Philip Lowe started his study of economics at high school in Wagga Wagga and finished it with a PhD from the Massachusetts Institute of Technology. Much thanks to his teacher, Mrs King, whose teaching style convinced him economics was interesting as well as important.

The great attraction of high school economics is its emphasis on linking theory to current events.

According to a speech he gave last week, when Lowe did the HSC in 1979, the standard exam question was: why does Australia have both high inflation and high unemployment ("stagflation") and what’s the government doing about it?

In those days there was much interest in the "misery index", which adds the inflation rate to the unemployment rate. We got to peaks well above 20 per cent. Today, however, it’s below 7 per cent.

As the Australian Bureau of Statistics advised this week, the consumer price index rose by just 1.6 per cent over the year to June. Which means it’s been below the Reserve’s inflation target of "between 2 and 3 per cent, on average, over the medium term" for almost five years.

So Lowe’s guess is that, these days, exam questions are likely to ask: why is inflation so low at the same time as unemployment is also low – and what’s the government doing about it?

Just to be of help, he told us how he’d answer the question – which is one of interest and importance to all of us, not just youngsters preparing for their finals.

He started by noting that very low inflation has become the norm in most economies. At present, three-quarters of advanced economies have an inflation rate below 2 per cent.

There’s no single answer, he says, but there are three factors that, together, help explain what’s happened.

First, the credibility of the monetary "frameworks" that central banks eventually adopted when, in the second half of the 1970s, they realised inflation was way too high and needed to be got under control.

It wasn’t until the early '90s that our Reserve Bank adopted its present target for inflation which, as Lowe says, helped cement low inflation “norms” in the economy. In econospeak, it provided an anchor for business and unions’ expectations about how much prices were likely to rise over the next year or two.

"Many people understand that if inflation were to pick up too much, the central bank would respond to make sure the pick-up was only temporary,” Lowe says.

It would do so by raising interest rates and so discouraging borrowing and spending, of course. Economists call this the "monetary policy reaction function".

(It’s one of the reasons for the old view among economists that attempts to use the budget to stimulate demand by cutting taxes or increasing government spending wouldn’t achieve much. The central bank, fearing the stimulus would push up inflation, would react by raising interest rates and so stymie it. In the new world of continuing weak demand and too-low inflation, however, central banks are most unlikely to react to budgetary stimulus in such a way, meaning the new view is that budgetary stimulus is very effective.)

Has inflation targeting worked? Well, annual inflation has averaged 2.4 per cent since the target was adopted, so it certainly seems to have.

The second part of Lowe’s explanation for very low inflation is that spare capacity to produce goods and services (including spare workers who are unemployed or under-employed) in many advanced economies means there’s little upward pressure on prices.

That certainly seems the case in Australia. Our unemployment rate could go a lot lower than its present 5.2 per cent without causing wages to take off – especially with our under-employment rate of 8.3 per cent.

Our labour market seems to be more flexible – and less inflation-prone - than it used to be.

The third part of his explanation is that changes in the structure of the economy caused by technology and globalisation seem to be keeping prices low.

For one thing, digitisation and globalisation seem to be lowering the cost of producing many goods. The entry of China and other emerging economies into the global trading system has added hundreds of millions of factory workers to the global market.

The prices of manufactured goods in the advanced economies have barely increased over the past couple of decades.

For another thing, globalisation and advances in technology are making markets more contestable and increasing competition. This is extending beyond manufacturing to almost every corner of the economy, including the services sector.

Historically, most services couldn’t be traded across national borders. But globalisation – driven mainly by advances in information and communication technology – means many services can now be delivered by somebody in another country.

Examples include preparation of architectural drawings, document design and publishing, and customer service roles (a nice name for call centres). As well, many tasks such as accounting and payroll have been automated.

The internet and its digital “platforms” have revolutionised services such as retail, media and entertainment, and transformed how we communicate, and search for information and compare prices.

"These changes are having a material effect on pricing, with services price inflation lower than it once was. Many firms know that if they don’t keep their prices down, another firm somewhere in the world might undercut them," Lowe says.

"And many workers are concerned that if the cost of employing them is too high, relative to their productivity [an important qualification], their employer might look overseas or consider automation."

More broadly, using the internet for better “price discovery” keeps the competitive pressure on firms.

The end result is a pervasive feeling of more competition. And more competition normally means lower prices.

What’s the government doing about low inflation and the deficient demand that is part of its cause?

Well, if you mean the elected government, the short answer is: not nearly enough. Especially when you remember how little scope the Reserve Bank has left to cut interest rates.

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Higher super: good for fund managers, not for workers

Do you have trouble understanding superannuation? Some government backbenchers are urging Scott Morrison to abandon or at least postpone the plan to phase-up the compulsory employer contribution from 9.5 per cent to 12 per cent of salary over the four years to July 2025. Good idea, or another attempt to cheat the worker?

One new backbencher has proposed that, since many low income-earners have a lot of demands on their budgets, super should be voluntary for everyone earning less than $50,000 a year. Whaddaya reckon?

You could be forgiven for being unsure. Super is complicated. You have to understand how it’s taxed and how it interacts with the age pension and its income and assets tests. I sometimes think that, with super, nothing is as it appears.

Take the notion of “employer contributions”. The government is forcing your boss to contribute to your retirement savings on top of the wage you’re paid. You beaut. Bring it on. The more the better.

Trouble is, economists believe that, in the end, it’s not the boss who pays, it’s the worker. How could that happen? Easy. Every time bosses are compelled to increase the rate of their contribution to their workers’ super, they compensate by granting ordinary pay rises that are smaller than they would have been.

After almost 30 years of playing the compulsory super game, that’s what the figures say has happened.

And ask yourself this: if employers really do foot the bill for their contributions to their employees’ super – if they come out of profits rather than wages – why isn’t business complaining loud and long about the plan to greatly increase those contributions?

Once you accept that employees end up paying for “employer” contributions, the question of whether they should be increased can be restated as: would you be happy for your pay to rise by about 2.5 per cent less than it would have over the four years to July 2025? And, ignoring other developments, stay that much lower every year for the rest of your working life?

The rational answer to that question is yes - provided the eventual improvement in my retirement income is sufficient to compensate me for the loss of the other things I could have done with all that money.

Before we consider answering that, here’s another thing that may not be as it appears. Compulsory super is a creation of Labor (and, if you hadn’t noticed, Paul Keating) and the unions. This was done in the belief that future generations would want more than the pension to live comfortably in retirement. Most people would live on a combination of age pension and super.

The Liberals opposed it from the start, saying they didn’t agree with compelling people to save. The Howard government scuttled Keating’s plan to increase compulsory contributions beyond the original 9 per cent.

Then, in 2013, the new Abbott government intervened to delay Kevin Rudd’s plan to get contributions up to 12 per cent by July 2019 – that is, now.

We’re asked to believe that the backbenchers are revolting because Morrison is refusing to abandon or further delay the already-legislated phase-up to 12 per cent by July 2025. But why would he reverse the Libs’ long-held opposition to compulsory super (which, by the way, delivers billions of dollars into “industry” super funds, in which half the trustees are union officials)?

I don’t believe it. Treasurer Josh Frydenberg is preparing to announce a wide-ranging inquiry into the interaction of super, the age pension and taxation. Since the next increase won’t happen until mid-2021, I think Morrison would simply prefer to announce a further curtailment of Labor’s plans in the context of the government’s response to that inquiry.

But why might an independent inquiry recommend against any further increase in the rate of compulsory contributions? Because, despite all the urging from the finance sector-types who make their high-paid living by taking a small annual bite out of every dollar the government forces us to leave in their care, in an unholy alliance with the union movement, the case for higher contributions is weak.

Recent detailed modelling by Brendan Coates, of the Grattan Institute – a non-aligned think tank that’s done much research into super – has found that the planned increase would leave many workers poorer over their entire lifetimes.

They would sacrifice a significantly increased share of their lifetime wages in exchange for little or no increase in their retirement income. Overall, and measured in today’s dollars, the typical worker would lose a cumulative total of about $30,000 over their lifetime, Coates estimates.

He finds that the lowest-paid 20 per cent of employees would be better off, the middle 50 per cent would be worse off, and the highest-paid 30 per cent would be better off.

Why? Partly because super tax breaks are still a lot greater for high income-earners, but mainly because, for workers in the middle, the operation of the age pension assets test would leave them sacrificing immediate income to increase their super payout, only to have their pension chopped back in consequence.

These results make me doubt the wisdom of making super voluntary for low income-earners. Many people are on low incomes not because they’re poor, but because their career is just getting started. It would work against the push for women to end their careers with more super than they do at present.

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