Swan's sleight of hand hides mining concession

Tony Abbott is right. Julia Gillard and Wayne Swan have grossly misled the public on the cost of their abject surrender to the three big mining companies over the former resources super profits tax.

They claimed that almost halving the rate of the tax - from 40 per cent to an effective 22.5 per cent - and making various other concessions demanded by the companies would reduce tax collections by just $1.5 billion over its first two years, a mere 12.5 per cent of the originally budgeted $12 billion.

How was that unbelievably small cost achieved? Partly by shifting the goal posts. As we now know, the revenue to be raised by the new version of the tax was estimated using higher prices for coal and iron ore than were used in estimating the revenue to be raised by the original version. The new estimates also used different assumed production volumes.

To what extent do these "parameter" revisions cause the revenue cost of the policy changes to be understated? Gillard and Swan are still refusing to say. Apparently, this is none of the electorate's damn business. So we're forced to rely on estimates by people not in full command of the facts.

These suggest the government's figure of $1.5 billion over the first two years understates the value of the concessions to the big miners by

$1.6 billion (according to sharemarket analysts at Goldman Sachs JBWere), or $3 billion (according to mining tax consultants quoted by David Uren of The Australian, who deserves special mention for pursuing this issue).

Let's be clear: there's nothing wrong with the government using more up-to-date parameters when it redoes its budget figuring. No, the crime is to do so without acknowledgement, let alone without indicating the value of the parameter changes. Swan not only failed to acknowledge the change, he avoided answering a direct question on whether he had changed any of the assumptions that underpinned the revenue estimates. (These figures have not been made public - you won't find them on Swan's website - but merely "circulated" to gallery journalists, presumably because Swan had something to hide.)

Coming from a treasurer, this isn't tricky behaviour, it's dishonesty. If you can't trust the Treasurer to be honest about the cost of measures, who can you trust? I can't think of a previous treasurer who betrayed our trust so badly.

But the other part of the sleight of hand is to change the tax in ways that have implications over many years, then tell us only about the first two. Telling us more would involve making assumptions about commodity prices and exchange rates, but that's just as true of the four years of estimates produced for every budget and budget review.

It's a weak excuse that could be overcome if the government wanted to do so. So again we're forced to rely on figuring by outsiders lacking the Treasury's knowledge. The Goldman Sachs analysts estimate that, on a like-with-like basis and using quite pessimistic assumptions about commodity prices, the cost to revenue of the changes imposed by the big three will total about $35 billion by 2019-20.

With the original tax package (that is, including all the tax concessions on which the resources tax revenue was to be spent) we were given no idea of whether it was revenue neutral beyond the first two years. It may not have been because the loss of revenue arising from lifting the superannuation guarantee to 12 per cent by 2019-20 will be huge.

But whatever the position originally, it's a safe bet it will be worse now the chief payers of the minerals resources rent tax have been allowed to redesign it.

Even so, there are a few points to make. Few people have noted that, according to Swan's figures, revenue will be $1 billion higher in the first year, but $2.5 billion lower in the second. These differences partly reflect the secret parameter changes, but they also seem to reflect the choice companies were given between writing off their assets at book value at an accelerated rate over five years (36 per cent in the first year, 24 per cent in the second), or writing them off at market value over 25 years (4 per cent a year).

Since we can be sure the companies will pick the method that favours them, this choice will end up reducing the amount the tax collects. In the early years, however, those companies opting for market value will pay more tax rather than less.

But it doesn't follow that all the tax saved by the big companies equals the amount lost by the taxman. Why not? Because Gillard and Swan have allowed the big three to rejig the tax in ways that suit them at the cost of the smaller miners, particularly those in the early years of their projects and those mining ventures yet to be born.

The original tax's now-abandoned guarantee to pick up 40 per cent of losses was of little value to the big boys, but (despite their claims to the contrary) of great value to the new small boys (as was also the now-abandoned plan to give a refundable rebate rather than a simple deduction for exploration costs).

Whereas under the original tax 2500 firms would have been affected, now only about 320 will be. But this means about 2200 mining companies will now not be relieved of paying state royalties. And those remaining in the tax net will get only a deduction against profits (and a carry-forward in the event of losses), not an automatic refund.

This greatly reduces the economic efficiency gain from the new tax because so many miners will remain subject to royalties based on volume or price, not profits. Well done.

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Why 600,000 out of work is a magic number

Who would have expected it? A year ago we thought we were headed for a severe recession and this week we learn the rate of unemployment is down to 5.1 per cent. Do you realise that's just a fraction above what economists - and the Gillard government - regard as full employment?

Huh? If 5 per cent of the labour force - 600,000 people - is still looking for work, how on earth can economists say we're at full employment? Good question. Unfortunately, economists don't have a good answer.

This year's budget papers - which seem to have been overtaken by events already - say the unemployment rate is expected to fall to 5 per cent by the middle of next year and to 4.75 per cent by mid-2012, "around levels consistent with full employment".

Last month a senior Treasury officer, Dr David Gruen, told a Senate committee it was "a longstanding practice" to regard full employment as 5 per cent, although there was "a reasonable band of uncertainty around that number".

"With the best will in the world, we cannot really tell whether it is 5 per cent or anywhere in the range, say, from about 4.75 per cent to 5.25 per cent," he told

the committee.

I guess the first thing to understand is that, to an economist, "full employment" does not mean what you and I think it does. It does not mean everyone who wants a job has found one.

Rather, it refers to the lowest sustainable rate of unemployment. That is, the lowest rate to which unemployment can fall before shortages of labour lead to excessive wage increases and start pushing up inflation.

In the jargon, this is the "non-accelerating-inflation rate of unemployment" (NAIRU). So in an economist's mind the NAIRU is synonymous with full employment.

As Gruen implied, no one knows for certain where the NAIRU is, though we do know it can shift over time.

So, though economists do make calculations to estimate where it lies, you really have to discover where it is by real-world experience.

When the unemployment rate got down to 4 per cent in early 2008, most economists would have regarded that as clearly below the NAIRU. The private-sector wage index rose by 4.3 per cent over the following year - hardly a wage explosion, but clearly on the high side, particularly when the productivity of labour has been improving so slowly.

And the underlying rate of inflation has now been above the target range of 2 per cent to 3 per cent for more than three years. So I guess that does confirm that the NAIRU is nearer 5 per cent than 4 per cent.

Economists actually regard 5 per cent as good because, not that long ago, they believed the NAIRU was up somewhere between 7 per cent and 8 per cent. The rest of us, on the other hand, are shocked by the idea that economists could be satisfied with unemployment no lower than 5 per cent.

And oldies can remember the 1950s, '60s and early '70s when full employment (and the NAIRU) was regarded as an unemployment rate no higher than 2 per cent.

The 2 per cent was easily justified as "frictional unemployment". At any time, roughly 2 per cent of the labour force are unemployed simply because they are moving between jobs, and thus of no concern. In those days people were unemployed so briefly many did not bother to register for the dole.

But how do economists explain why the lowest point at which inflation pressure can be quiescent has shifted from 2 per cent to 5 per cent over the past 35 years or so? Well, the reason you can get inflationary wage pressure while still having 600,000 people looking for jobs is "structural mismatch": the remaining unemployed either don't have the skills employers are seeking or don't live in the parts of the country where those workers are being sought.

But that does not explain why structural mismatch is a much greater problem today than it was 40 years ago. So the truth is, economists can't offer a thorough explanation for why the full-employment rate has risen, as many of them will admit.

It is worth noting, however, that since the postwar Golden Age ended with the arrival of stagflation in the mid-1970s, NAIRUs have risen significantly in most developed economies.

And just because economists can prove it, that doesn't stop them having theories - rival theories, naturally.

Economists of a neo-classical disposition incline to the view that the full-employment rate is higher these days because a combination of increased interventions in the economy - minimum wage rates that are too high, unemployment benefits that are too generous and unfair dismissal laws - have stopped the labour market functioning as efficiently as it used to.

Limits on employers' freedom to dismiss unsatisfactory workers have made them more reluctant to hire those workers at the bottom of the barrel, it's argued.

Or, unduly high minimum wages effectively price unattractive workers out of a job, while generous unemployment benefits reduce the incentive for people to find work.

There may be other reasons why people don't try as hard to find work these days: because the stigma of being unemployed has declined, because dual-income households reduce the pressure on one partner to find work, which may be particularly true of married women.

But these arguments aren't terribly convincing. Relative to average income, our dole payments are very low.

And while it's true our minimum wage is quite high relative to average income, our NAIRU isn't that much higher than America's, even though its minimum wage is terribly low.

So economists of a more Keynesian disposition try to explain the higher full-employment rate more in terms of how the structure of the economy has

changed (as opposed to how governments have made prices more inflexible). When you get down to an unemployment rate of 5 per cent, most of those who have been unemployed for any length of time are unskilled, with a chequered work history. It may be that the kind of jobs suitable for such people no longer exist to the same extent they once did.

And there's a suspicion that where the NAIRU lies is affected by how rapidly you approach it. If unemployment falls rapidly, you may hit the NAIRU at a

higher level than if growth is more sedate and it takes a lot longer to get unemployment down.

Sorry, but all this is about the best explanation economists can offer. There is a lot economists do not know.

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Green jobs just muddy the climate-change waters

A cartoon by Jon Kudelka shows Julia Gillard ticking off items on her to-do list: first, appease billionaires; second, appease xenophobes; third, appease climate sceptics. Too true ... although, actually, when she has finished appeasing those who live in fear of boat people her last bit of pre-election deck-clearing will be to appease those who regret the government's decision to walk away from its emissions trading scheme by announcing a program of government subsidies to induce people to reduce their emissions directly.

Amazing though it may seem, the climate-change-denying opposition has a post-trading scheme policy to encourage "direct action", whereas the government - which still protests its acceptance of human-caused climate change - doesn't.

It's a fair bet that when we see Gillard's direct-action policy it will come complete with boasts about how many "green jobs" it will create.

Creating green jobs is all the rage. About a year ago Kevin Rudd promised to create 50,000 of them. Tony Abbott has plans for a standing army of 15,000 green workers who could be deployed across the country. And every environmental group or renewable energy lobby group wants to tell us how many "green-collar jobs" could be generated if only we'd do as they say.

It seems the notion of green jobs arose as a response to the claims of the opponents of climate policy that moving to a low-carbon economy would destroy lots of jobs. No it wouldn't, environmentalists cried, it would create lots of jobs. What's more, they would be green jobs.

But as the Australia Institute warns in a policy brief to be released today, there's a lot of woolly thinking about green jobs. It seems to be little more than a propaganda tool.

For a start, there has been little attempt to define what constitutes a green job. If, for instance, a job maintaining a wind turbine is a green job, what about a job in the business that makes the turbines?

And if it's green to manufacture steel turbines, what about the jobs of the people who mine the iron ore and coking coal needed to make the steel? But if it's not green to be a miner, would it be better for us to import all the turbines we need so the sin of being non-green was on someone else's head?

Should people who work in industries with a low environmental impact be regarded as having green jobs? If so, a significant proportion of all our existing jobs - particularly those in health, education and community services - are green.

But what about jobs in industries that have reduced their ecological footprint, even though it remains substantial? Are these jobs more green or less green than jobs in industries whose footprint has always been small?

As a general rule, industries that are capital-intensive are likely to have a bigger footprint than industries that are labour-intensive, such as service industries. Does this mean we could make the economy greener by abandoning our age-old quest to use machines to replace workers wherever possible?

Do workers whose job is to return a mine site to nature after it has been worked out qualify as green-collar workers? If so, what about workers who clean up after oil spills?

And what about jobs that make the natural environment more accessible to people? If, for instance, you employ some young people to improve the signs on a bush-walking track (for which I'm always grateful) are these green jobs? The advocates of such projects seem to think so.

Visiting the great outdoors may make people more environmentally conscious. But what if the greater accessibility attracts more people and thus adds to the degradation of the area? Would the green jobs then turn brown?

If I were to drive all around the state - or fly all around the world - educating people about the damage the use of fossil fuels does to the climate, would that make me a green-collar worker?

Give up? I reckon it's virtually impossible to come up with a watertight definition of green jobs. But I don't think that matters. As the Australia Institute's report argues, focusing on green jobs is at best a distraction and at worse a snare and a delusion. The object of the climate change exercise is to move to an economy where little of our energy needs are met by burning fossil fuels, thereby making us a "low-carbon economy" and greatly reducing our emissions of greenhouse gases.

Focus on that and the jobs will look after themselves. What seems to be missing from the preoccupation with green jobs is an understanding that all economic activity creates jobs. Moving to a low-carbon economy may well involve reducing jobs in industries that produce fossil fuels, but it will also create them in renewable-energy industries. And even should producing a quantity of energy from solar, wind or whatever involve fewer jobs than producing the same quantity from coal, that's not a problem either. This greater productivity of labour would leave income to be spent elsewhere in the economy - probably the services sector - where it would create jobs.

Our businesses have been using "labour-saving equipment" to replace workers for 200 years and it hasn't cause mass unemployment yet. (It's true, however, that the workers displaced from fossil-fuel industries may not be well placed to take the jobs created in the renewable industries or elsewhere, but that problem - which does need to be dealt with - is common to all the changes in the structure of the economy that continuous technological advance has caused over the centuries.)

It's OK for governments to spend money for the dominant purpose of creating jobs when they're fighting to urgently reduce the impact of recession. Apart from that, however, the money they spend should be aimed at achieving its nominal purpose. The number of jobs this spending creates should be incidental.

If we continue our muddled thinking about green jobs, we risk having politicians trying to curry our favour by wasting money on schemes that will do little to combat climate change.

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Economists help cause gutless government

I hope I'm wrong, but I fear the all-in fight over the resource super profits tax will in time be seen to have brought the era of micro-economic reform to an end. If so, the economics profession will bear its share of the blame.

You could argue (as I did on Saturday) that, though the compromise deal Julia Gillard came up with is far from perfect, it still represents a net increase in economic efficiency relative to the present arrangements. But that ignores the psychological scars this dog fight will leave on the pollies.

You have to ask yourself what conclusions the politicians - of both sides; they're very similar animals - will draw, first from Kevin Rudd's palpable loss of credibility following his decision to dump the emissions trading scheme, and second from the government's near-death experience with the resource tax.

There is a host of useful lessons you'd hope the pollies would draw: don't over-promise and under-deliver, don't announce contentious reforms just before an election, don't take on too much, don't underestimate the attention and effort needed to sell unpopular reforms to a confused electorate, and more.

But the lesson the pollies are more likely to draw is much more damaging: don't let economists sell you complex reforms that are almost impossible to explain to mere mortals because the economists will fall to arguing among themselves and leave you in the lurch.

Think about it: what is reform? It's governments making changes that economic theory says will make us all better off, but in the process arousing intense resistance from those who fear their rents are threatened.

Governments then face the problem that the great number of modest winners stay mute while the small number of big losers scream blue murder. As we've just seen, the political problem is greatly compounded by the ease with which powerful vested interests can convince the public the interests' problem is actually the public's problem.

The antidote to this propaganda involves economic reasoning that's beyond most of the public's comprehension and which the pollies find almost impossible to explain without the help of economists capable of speaking plain English.

When people don't understand policy debates and don't know what to believe, they fall back on the opinions of presumed experts, such as prominent business people. But business people are either on the make or they're adhering to an honour-among-thieves ethic that you keep mum while fellow business people are trying it on (we've just seen the Business Council doing exactly this on the resource tax).

The other, better qualified authority source is the economics profession. But reforming pollies have learnt economists always let you down. You think you're fighting their good fight, but they're more inclined to attack you or muddy the water than support you. There are different kinds of economists, of course. The econocrats generally aren't free to speak publicly on policy.

Most market and private sector economists are prevented by their employers from joining the non-macro policy debate, prevented from offending clients or potential clients and sometimes required to spruik their firm's interests.

Then you have the self-employed economic consultants, whose arguments are for hire - sometimes by governments trying to side-step the econocrats, but usually by vested interests battling the government.

Apart from a handful of media economic commentators who are free to express their opinions (those working for Fairfax, anyway) that leaves only the academic economists free to take sides and speak out.

The great majority of academics don't say boo beyond the staff room. But the few who do are far more likely to argue the toss with government policies than support them.

(The 21 academic economists who issued a statement supporting the resource super profits tax are an honourable exception.) I have sympathy for the Treasury secretary's expression of the frustration ministers of both colours feel at the unsupportive contributions of academics.

Ken Henry acknowledged the value of the academic "contest of ideas", but said there were "occasions on which economists might, at least for a period, put down their weapons and join a consensus".

The reaction of the academics wasn't just defensive, it dripped with righteous indignation. Professor Warwick McKibbin, of the Australian National University, said Henry "can't believe you should have consensus because it is better to have bad policy that everyone agrees with than eventually get good policy that will work".

Note the assumptions in that remark: the policies governments advance are always bad and always in need of correction by that fount of wisdom, W. McKibbin. It tells you more about his personality than the state of public policy. I don't remember him ever doing anything but criticise. McKibbin was among the first economists to propose a detailed solution to climate change and is an expert of international rank. But no government has accepted his solution and now he tears down every proposal different from his own.

He's so negative the opponents of action see him as an ally.

Professor Joshua Gans, of Melbourne Business School, said "you have to believe Ken Henry really doesn't understand academics at all when he publicly says stuff like this". He had supported various government policies, but was never invited to help improve those policies ("something they could clearly use"). Failing that, he would "speak my mind from the sidelines".

It's a free country, and if academics are willing only to advocate (their personal version of) policy perfection and not support policies that inevitably and unavoidably are less than first-best, no one can make them.

But let's not hear any economists whose only contribution is a counsel of perfection complain governments lack the "political will" to implement economic reform policies even economists refuse to support.

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Battle over tax leaves Labor with bloody nose

The deal Julia Gillard has done on the mining tax is bad for her government's reputation, bad for democracy and bad for the future of economic reform, but not too bad for the economy.

The immediate reaction of most parties will be relief. What was seen as a great threat has gone away.

The big miners will be quietly congratulating themselves on the extent of their victory, but leaving it to their friendly business commentators to do the crowing for them.

Concessions extracted from the government because the big mining companies were holding a gun to its head will be interpreted as proof that all the miners' dubious arguments against the resources super profits tax were valid.

But the initial emotional reaction to the deal is one thing, the longer-term consequences are another.

Although Gillard, being a new prime minister, will be given a lot of slack by the electorate, the Labor government's backdown on the mining tax, coming on top of its retreat on the emissions trading scheme, will entrench its reputation for weakness and lack of conviction, and further embolden vested interests to actively resist legislation they don't like.

Labor will be looking for people to blame, but it should consider its own part in this political disaster. Its decision to adopt such a controversial reform so close to an election was a basic political miscalculation.

Its belief that, simply by naming the tax a "super profits" tax, it could harness all the public's envious resentment of the rich mining companies, which would be sufficient to outweigh all the propaganda the miners would put up, was another bad call.

This government has shown an inability to set priorities for itself, tried to do too much, and grossly underestimated the degree of ground-preparing, consulting and explaining needed to ensure a controversial reform makes it from announcement to reality.

Professor Ross Garnaut said early in this war that it would be a test of whether difficult economic reform remained possible in Australia, or whether powerful interest groups now had too much sway over the political process.

By that test we haven't done well, even if a significant element of reform remains in the compromise forced on the government. It's now clear to all that governments daring to take on the mighty mining industry can expect to lose.

The big miners have won their fight against the emissions trading scheme, and now they'll be seen as achieving major concessions in the attempt to make them share with the owners of the resources a larger proportion of the windfall gains from the resources boom.

These guys are giant killers. They saved themselves $1.5 billion over the first two years - and probably a lot more in later years - for the price of an advertising campaign estimated to have cost just $7 million.

They prove that if you're big enough, rich enough and aggressive enough you can push around the elected government of Australia.

This Labor government has always been afraid of big business and now its drubbing at the hands of three big companies will deepen that fear. What do you reckon are the chances of a re-elected Labor government returning to the Henry report for further ideas on tax reform?

I fear this is the end for controversial micro-economic reform from Labor. And it's hard to see the cause being taken up by a future Liberal government. Don't forget the major part the Abbott opposition's unprincipled opportunism played in this affair and in the abandonment of the emissions trading scheme before it.

The deal involves changing the (dumb) name of the resources super profits tax to the minerals resource rent tax, turning it into a more generous version of the existing petroleum resource rent tax and extending the coverage of the petroleum tax.

That's not the end of the world. The miners had been expecting something similar to petroleum tax and, had that been what the government decided to introduce, it would have been greeted by economists as a big improvement in the efficiency of resource taxation.

In theory, the originally proposed tax was more economically efficient than the petroleum tax - that is, it would have done less to distort miners' choices about what projects to undertake. But some of the miners' criticisms of it - namely, that bankers would discount for purposes of collateral the value of the government's guarantee to cover 40 per cent of project losses - were genuine.

The main difference in changing the original tax to be more like the petroleum tax is to drop the guarantee to pick up 40 per cent of losses, in return for the cut-in point for the application of the rent tax being raised from the long-term bond rate to the long-term bond rate plus 7 percentage points.

This is just a change in the way the tax allows for "risk" in the universally accepted proposition that economic rent is what projects earn in excess of their risk-adjusted rate of return (the long-term bond rate being taken as the risk-free rate of return). Don't forget that those minerals that remain covered by the new tax - iron ore and coal - will still have the new tax effectively take the place of the states' volume- or price-based (but not profit-based) royalty charges. This feature does much to improve efficiency.

What's hard to understand about the deal is that so many changes could be made at such a small net loss of revenue from the new tax: $1.5 billion over the first two years. Three possible explanations come to mind. First, the original costings had a lot of leeway built into them in anticipation of some concessions having to be granted.

Second, the ultimate cost of the concessions won't be felt until after the first two years of the tax (the estimates for which we've never been shown).

Third, the exclusion of many other minerals from the tax may involve a net saving to revenue because those firms would have gained from not having to pay state royalties while paying little or no resource rent tax. If so, the small miners have only themselves to blame for throwing in their lot with the big boys and then being dudded.

And the same goes for all those businesses now facing a cut in company tax of only 1 percentage point rather than 2 points because they stood back while their big mining mates did over the government at their expense.

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Tiny tax cut a blessing for battlers

Forgive me, but I'm tickled by the latest joke: the good thing about having a woman as prime minister is we don't have to pay her as much. Actually, the amount the prime minister gets paid is just one of the many things that won't be changed by Labor's leadership switch.

A new face, a new atmosphere, a new attitude towards the government for many people, but surprisingly little change in policy.

Take, for instance, the tax cut we get from tomorrow. Its arrival has been forgotten in all the excitement, but it's still coming. It's the third of the three annual tax cuts Kevin Rudd promised and, though our budgetary circumstances have changed markedly since then, there was never much doubt it would be delivered.

Even so, the government has waxed hot and cold on the promised cuts. This time last year it didn't want to draw attention to them, perhaps because it might have seemed profligate adding a tax cut to all the cash it had been splashing around.

This year it's happy to have us noticing the cut because people have begun complaining again about "cost of living pressures". So, we're told - conveniently - the cut is intended to help.

But that's not all.

It's remarkable the things politicians think our forgetfulness will allow them to get away with saying. Wayne Swan claimed recently, "the Rudd government designed these tax cuts to boost incentives for labour force participation..." blah, blah, blah.

In truth, the cuts were designed by Peter Costello. Rudd simply pinched them from John Howard during the election campaign. The cut we get from tomorrow, the first day of the new financial year, will be the eighth we've had in a row, surely a record.

And next year? Next year we'll get nothing. Indeed, unless a change of government brings a change of policy, we're unlikely to see another tax cut for four years, maybe longer. That's because Labor has vowed not to cut taxes again until the budget is back in surplus and the surplus is equivalent to at least 1 per cent of gross domestic product (by then, about $17 billion).

So it's good to take note of tomorrow's cut, even if for most people it isn't all that generous. People with part-time jobs, or full-timers close to the minimum wage, earning between $16,000 and $37,000 a year will save a princely $2.90 a week. Those earning between $37,000 and $67,000 will save $8.65 a week.

From there up to $80,000 a year, the saving drops to $5.80 a week. But from there on it starts rising, to reach a peak of $25 a week for those battlers on $180,000 a year or more.

The higher dollar savings going to people on very high incomes shouldn't surprise you and, since those people pay a much higher proportion of their income in tax, this doesn't prove the tax cuts are biased in favour of the well-off.

By the same token, however, the government's trick of showing us the percentage decline in the amount of tax paid at each level of income is another unreliable guide to who benefits most.

This will always show those on the lowest incomes - and thus paying the lowest amounts of tax - make the biggest proportional savings.

If, for instance, I was formerly paying just $1 a week in taxation and the tax cut relieved me of this, the government could claim it had given me a saving of 100 per cent. But that would hardly leave me much better off. No, the tax economists will tell you the right way to determine the fairness of a tax cut is to look at the change in the proportion of people's total income they lose in tax - that is, their "average tax rate".

Judged this way, it turns out the maximum saving of about 1¢ in every dollar of income goes to people earning between $37,000 and $50,000 a year - quite modest incomes, well below the average full-time earnings of about $67,000 a year.

The workers who do best from this tax cut are those earning up to $30,000 a year less than average earnings. But, surprisingly, those who do worst are those earning up to almost $30,000 a year more than average earnings.

People earning incomes a bit below or above $180,000 a year save only about 0.7¢ in every dollar of income. Someone on $300,000 a year saves just 0.4¢ in the dollar.

Tax cuts can be expensive from the taxman's point of view. Just how expensive they are turns not on how much you give the high-income-earners (there aren't enough of them to make a big difference) but on how much you give those on incomes around the middle.

That's because such a high proportion of incomes are clustered around the middle. But the middle (or median) income is actually lower than average (or mean) full-time earnings of $67,000 a year. And since there are a lot more people on incomes a bit below the mean than a bit above it, this seemingly modest tax cut is actually quite an expensive one, coming at a cost to revenue of $3.8 billion a year.

So, largely by chance, these tax cuts really will do a bit to help a lot of genuine battlers cope with the rising cost of living.

Will it satisfy them? I very much doubt it. Because wages - and age pensions - rise faster than the cost of living, complaints about the rising cost of living are actually a cover for worries about the success of our efforts to keep up with our peers' ever-rising standard of living.

Most of us are pounding away on this hedonic treadmill, as psychologists call it, and all our economists and politicians can think to do is help us run faster.

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Gillard has little room for compromise on tax

Ending the fight over the resource super profits tax may be at the top of Julia Gillard's to-do list, but she has no scope to drop the tax and little scope to reduce it.

Surprisingly to some, the reason the new Prime Minister can't drop the tax is not because it would leave a hole in the budget. Arithmetically, the tax could be dropped without affecting the government's commitment (repeated by Gillard) to have the budget back in surplus in 2012-13.

Why? Because, as Wayne Swan repeated on Friday, the resource tax is part of a package of tax changes. That package is essentially revenue-neutral and thus detachable from the budget.

Virtually all the proceeds of the tax would be used to pay for the other alleged reforms in the package: the cut in the rate of company tax, the instant asset write-off for small business, the various superannuation concessions, the resource exploration rebate, the standard tax deduction, the discount on tax on interest income and contributions to the planned state infrastructure fund.

Since the resource tax isn't due to start until July 2012, all the measures it pays for will be phased in from that date, a further indication it's part of a package.

Thus dropping the tax wouldn't leave a hole in the budget, but it would mean dropping all the political goodies it would have paid for.

So that's the first reason Gillard can't just drop the resource tax. It would rob the government of all its election promises and much of its second-term agenda; its rationale for seeking re-election.

But there's a deeper reason. Kevin Rudd, and now Gillard, have repeatedly insisted the miners pay the owners of the resources they mine a "fairer share" of the proceeds. Simply walking away from the tax because it had proved unpopular with the miners would be seen as a repeat of Rudd's decision to walk away from the emissions trading scheme (something he now says Gillard and Swan urged him to do).

And just as even people who were relieved to see the back of the trading scheme still concluded Rudd lacked convictions and the courage of them, so people with doubts about the wisdom of the resource tax would nonetheless conclude Gillard was equally lacking in convictions - an impression that would be reinforced by the motivation behind her brutal installation as leader.

If anything's crystal clear from Rudd's remarkable decline in public esteem following his cowardly abandonment of the emissions trading scheme, it's that voters expect their leaders to stand for something. Show them your sole motive is clinging to office and you're dead meat.

Combine the voters' desire for strength of character with the budgetary arithmetic and you see why Gillard has little scope to reduce the revenue raised by the resource tax. Cut too much from expected collections and you look weak in the face of powerful vested interests and you have to cut back your promised tax goodies to fit.

Considering the way business people have either stood silent or actively sympathised with the miners' resistance to paying more tax, it would serve them right if the net cost of reducing the tax was covered by reducing the planned 2 percentage point cut in the company tax rate.

Gillard will need to distinguish between changing those features of the resource tax the miners find most objectionable and simply reducing the burden of the tax. The former is a lot easier to concede than the latter.

Resource rent taxes come in different models. Ken Henry's version is theoretically superior to the present petroleum resource rent tax, with the latter's less generous treatment of losses but its threshold for the tax set at the long-term government bond rate plus 5 percentage points.

But it seems the miners were expecting the extension of the petroleum tax. They've been hugely critical of the Henry tax's guaranteed 40 per cent rebate on losses in place of the extra 5 percentage points on the threshold.

Gillard could accommodate them on this, and probably also exclude various lower value resources from the tax regime, at no great net cost to revenue - particularly if the planned move to a rebate (rather than a deduction) for exploration expenses was also abandoned.

This would probably make a lot of the smaller miners less unhappy and it would also yield modest savings to the big miners. Would it be sufficient to satisfy the big boys? I doubt it.

Here's where the "negotiations" (why an elected government should negotiate with unelected vested interests I don't know) get hard. The big boys' demand that the tax not apply to existing projects is simply impossible to accede to.

Why? Because, leaving aside the weakness of the argument that they should be excluded, it's clear existing projects would account for all the revenue. Indeed, it's a safe bet the reason BHP Billiton, Rio Tinto and Xstrata are carrying on so much is they'll be paying the lion's share of the $9 billion a year in revenue.

That leaves the possibility of cutting the 40 per cent rate of the resource tax. But this would be hugely expensive. Independent modelling I have commissioned (using a pocket calculator and the back of an envelope) suggests cutting the rate just to 35 per cent would cost about $1.1 billion a year.

It's therefore possible no compromise Gillard could come up with would satisfy the big miners now they've had the taste of blood.

But whether they go quietly or keep fighting turns on Gillard's skills as a conciliator and whether she can use a combination of offered concessions and argument to convince most voters that the miners' objection to giving the community a greater share of their windfall gains is unreasonable.

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Model way of conning us all

A new prime minister but the same old problem: the mining industry claims the resource super-profits tax would damage it and the economy, whereas the government claims it would be great for the industry and the economy.

And both sides have "independent modelling" to support their claims.

If that doesn't make you sceptical about the use of modelling in the political debate, it should. But if you need more, try this: the two seemingly diametrically opposed modelling exercises were undertaken by the same commercial firm, KPMG.

It's taking people - even those close to the political action - a long time to wake up to the truth that the use of modelling in political arguments is just a way of conning the electorate. The less you know about economic models and how they work, the more impressed you are by their seemingly authoritative results.

The economy is a highly complex mechanism, which economists don't understand all that well. When you construct a mathematical model of the economy, you end up with a hugely oversimplified version of the real thing.

Often you can't test what you'd like to test - and what the punters assume you tested - because the model isn't sophisticated enough or because the data series you'd need don't exist. You end up with a model full of "proxies" (the best substitutes you can find). You can't model shades of grey, so you make do with black and white.

In other words, you have to make lots of assumptions. Economists don't know how the economy works; they just have rival theories about how it works. So their models are based on one theory or another.

The results thrown up by models are based heavily on the assumptions used. Use this set of assumptions, get that result. Use a different set, get a different result. Tell them what results you'd like and competent modellers can find the assumptions that produce what you want.

Economists don't accept the results of someone else's modelling until they know what assumptions were used and decide whether they consider them realistic or consistent with their own prior beliefs. Ideally, they want to determine which particular assumptions are driving the results.

Honest use of modelling results highlights the key assumptions used. But that is never the way modelling results are used in the political debate. Rather, the people who paid for the modelling quote a version of the results as impressive as possible and quite unqualified. The assumptions on which the results are based are never mentioned. They're trying to con the uninitiated.

The government paid KPMG Econtech to model the long-run effects on the economy of the resource super-profits tax and the cut in the rate of company tax. The government says the results were a "reform dividend" of a 0.7 per cent increase in long-run gross domestic product and a long-run increase in real average after-tax wages of 1.1 per cent.

If the long run is 15 or 20 or 30 years (we're not told), that's a pretty modest dividend. And the key assumption? Apparently, that the changes would make the tax system more economically efficient (because economic theory says they would).

Get it? If you thought the modelling was testing whether the changes would be good for the economy, you were conned. All the modelling tells us is by how much the changes would benefit the economy if they're economically efficient as assumed ... given all the other assumptions.

The modelling KPMG prepared for the industry lobby group, the Minerals Council of Australia, was begun in September last year - so much for the claim the industry was "ambushed" by the government.

It found that the impact of a higher effective tax rate and funding costs above the long-term government bond rate would be to reduce the net present value of new mining projects under evaluation. "This is likely to result in mining companies deferring or cancelling Australian mining projects in the short to medium term."

But what were the key assumptions used to achieve this result? I can tell you thanks to an evaluation of the study by Professor Paul Frijters, of the University of Queensland, found on the clubtroppo.com.au blog site.

He says that, rather than looking at what the new tax would do to all possible future projects, the report looks at the "second quartile" of all projects. That is, not the 25 per cent of most profitable projects but the 25 per cent after those.

"This is, of course, because the first quartile will go ahead anyway and the third quartile will probably see increases in net present value due to the cost-sharing in the resource super-profits tax. It loads the dice towards the negative to focus on only 25 per cent of all considered future projects," Frijters says.

Even so, Frijters says the study relies on two tricks to get its low net present values. In four out of six cases it assumes new projects have to obtain their equity capital at a cost of 15 per cent a year. And it assumes all projects last 30 years, even those that soon fail.

The 15 per cent required return is based on actual returns to equity over the past 30 years (including capital gains) which are unlikely to be repeated in the coming 30 years (you can't go on growing by 15 per cent a year forever), rather than the cost of obtaining capital.

Frijters says huge mining companies should be able to use corporate bonds to borrow capital for about 8 per cent. Clearly, inflating the assumed cost of capital makes projects appear less profitable.

Given this inflated cost of capital, the assumption that even failed projects last 30 years hugely reduces the value of the new tax's guarantee of a 40 per cent rebate on all losses, because firms have to wait up to 30 years to receive their rebate, with the value of that rebate indexed by only the long-term government bond rate.

I noted, too, the assumption that the guaranteed 40 per cent rebate on losses doesn't affect the cost of equity capital, the cost of borrowed capital or the proportions of each that are used.

So a key attraction of the proposed tax is effectively ignored as, remarkably, these economists assume businesses don't respond to incentives.

Frijters concludes that, in his mind, the report carries a big sticker saying "some poor competent modeller was told to make up a set of assumptions that would help the cause of a rich client".

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Our media roasts old chestnuts

If a genie appeared from a bottle and offered me one wish, I'd choose to be a columnist on a major newspaper. So I guess you could say I love my job. But there are times when I feel compelled to warn people to be careful about what they read, hear and see in the media.

Many people assume the media give them a representative picture of what's going on in the world beyond their own experience. But this is a misunderstanding of the role of the news media and the nature of "news".

The media select from all the things happening in the world only those things they consider "newsworthy" and thus worth drawing to our attention. What is newsworthy? Anything the media believe their audience will find interesting and nothing they fear the audience will find boring.

What's interesting? Anything unusual. But also anything threatening. It's perfectly clear that people find bad news more interesting than good news, which is why the media give prominence to things that are going wrong and say little about things that are going well.

Most of what's happening in the world is highly predictable and terribly ordinary. This means much news is selected because it's unrepresentative. So there's a high risk it will leave people with a mistaken impression of what's happening in the world.

Journalists like to believe everything they report is new. In truth, it's often just a new example of a familiar story, one the journos know the audience loves to hear again. Sometimes a new, offbeat angle is ignored so the story can be forced to fit a tried-and-true formula.

A lot of news is selected because it will appeal to the audience's prejudices or stir people's emotions in the way they like to be stirred. Consider some recent examples from my field of economic news.

There has been much indignation over the Keneally government's decision to change the tax on poker machines in hotels, with suggestions of undue influence by the Australian Hotels Association. About 60 per cent of hotels with pokies - those that don't make much out of them - will now pay less tax or even no tax.

You have to read the reports carefully to discover the changes are actually "revenue neutral", meaning the savings to the 60 per cent of hotels will be exactly offset by the higher tax paid by the remaining 40 per cent, leaving the government's total revenue unaffected.

Rather deflating of the righteous indignation, don't you think?

The media make no pretence of being bound by the scientific method. Economists are always being reminded not to draw general conclusions from anecdotal evidence rather than economy-wide statistics.

But the media are tellers of stories. They're the industrialised equivalent of cavemen sitting around the fire at night swapping yarns. The telling of stories about other people meets one of our most primitive human needs.

What it doesn't do, however, is give us an accurate picture of what's happening in the world. Take all the stories we're hearing about waste in the Rudd government's program to stimulate the economy by constructing a new building at every primary school.

News gathering is selective. People with complaints of waste - justified or otherwise - have had no trouble getting publicity. People without complaints don't bother approaching the media. And where reporters have encountered people saying everything was fine, these facts would have been ignored as "not news".

There have been enough anecdotes to convince me waste has been a significant problem. The real question is: how significant? What proportion of schools has experienced wastefulness? What proportion of the government's spending has been wasted?

No number of examples of alleged waste can answer these questions. What they can do is cause people who don't understand the biases involved in news gathering to gain the impression "the waste has been huge" or even "all that money has been wasted".

The one thorough report we've seen so far came from the federal Auditor-General. It was critical, but far from damning. One of his findings was that 95 per cent of school principals agreed they were confident the funds "will provide an improvement to my school, which will be of ongoing value to my school and school community".

Every year since 1997 the Reserve Bank has published an annual survey of the fees banks charge to their business and household customers. And every year the media turn the survey results into the same much-loved story: huge increase in the fees banks rip from you and me.

This year, however, the story tended to be relegated to the business section, though the same formula was used: huge increase in the fees banks charge businesses.

You had to read the reports carefully to get the real story: last financial year the fees the banks charged households grew by 3 per cent (the lowest increase since the survey began and far less than the 8 per cent increases in the two previous years), whereas fees charged to business leapt by 13 per cent (far more than in the two previous years).

Most of the growth in fees collected from households came from charges paid by the greater number of people choosing to break their fixed-rate mortgage contracts, but this was largely offset by a fall in banks' income from transaction and account-keeping fees. Much of this was explained by the banks' offers to waive fees to people who made regular deposits, part of their greatly increased competition to attract deposits.

By contrast, most of the huge growth in fees collected from business came from higher fees to existing customers now considered to be more risky and higher fees on undrawn overdrafts.

The story no one thinks worth writing is that since the global financial crisis, the banks have gone easier on their household customers but harder on their business customers.

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God give us better armed forces, but not yet

Kevin Rudd's chronic tendency to over-promise and under-deliver means the Australian Strategic Policy Institute's annual review of the defence budget is always an object lesson in how his long-suffering purse-string ministers manage to square the budget circle each year.

The fact that the Howard government was prepared to neglect many areas of spending that the Rudd government isn't - education and infrastructure, for openers - doesn't leave it hard to believe Rudd will be economising in areas John Howard favoured, with spending on defence the prime example.

Not, of course, that Rudd hasn't promised to spend a lot more on defence. In his defence white paper delivered a week or two before last year's budget, he matched Howard's commitment to 3 per cent real growth a year in defence spending until 2017-18, and 2.2 per cent thereafter until 2030.

To be fair to him, he also announced a "strategic reform program" in which $20.6 billion worth of the real growth would be covered by savings.

These brave plans took their first blow just two weeks later, when last year's budget cut $8.8 billion in funding from the following six years and deferred it to undisclosed years beyond.

Clearly, the goal of returning the budget to surplus (which includes limiting the real growth in overall budget spending to 2 per cent a year) was given priority over plans to strengthen our defence capability.

The author of the institute's review, Dr Mark Thomson, says that, on the face of it, defence was let off lightly in this year's budget. There were no further spending deferrals (not within the period of the forward estimates, anyway).

And defence was given a $1.6 billion "supplementation" to cover the cost of overseas deployments over the next four years, although it was required to absorb almost all of the $1.1 billion cost of enhanced protection for our forces in Afghanistan.

Defence spending is budgeted to increase by 3.6 per cent in real terms in the coming financial year, reaching almost $27 billion. What's wrong with that?

Just that the job done on defence spending in last year's budget was so thorough it didn't need further adjustment this year. For the following two years, spending is planned to fall in real terms, before recovering in 2013-14 (which just happens to be the year after we're now projected to have the budget back in wafer-thin surplus).

Thomson points out that the now-expected budget surplus of $1 billion in 2012-13 would not have been possible had last year's budget not deferred $3.4 billion of defence funding in that year.

The government now has a lot of credibility riding on the achievement of a surplus that year. If this looked in doubt, how reluctant do you reckon the purse-string ministers would be to push a bit more defence spending off into the future?

But Thomson notes that defence is already holding a lot of IOUs. Real spending is projected to recover the following year, 2013-14. After that, the catch-up needed to deliver the promised average 3 per cent real growth in spending should see defence funding increase by 29 per cent over five years.

Perhaps by then the resuming resources boom will be so well entrenched that Treasury's coffers will again be overflowing, so accommodating such huge real growth in defence spending will be no probs. Failing that, however, I don't find it hard to imagine the government welching on some of those IOUs.

The record spending budgeted for in the coming financial year sounds more comfortable than it is. Thomson says money available to initiate new equipment projects will have fallen by 55 per cent on the forward estimates in last year's budget, with further falls of 42 per cent and 36 per cent in the following two years. Only some of that could be explained by a higher Aussie dollar.

When Lindsay Tanner was shadow finance minister before the 2007 election he invited various worthies (including yours truly) to offer suggestions on ways the budget papers could be made more transparent and generally more informative to people on the outside of government.

These suggestions were developed into the Operation Sunlight policy Labor took to the election and has, we're assured, been implemented now it's in government. But Thomson complains of a lot of newly darkened corners in the defence budget.

He says the government ceased disclosing funding deferrals in its first budget. And this year, "in a marked departure from previous years, the budget papers do not list the projects planned for approval in the coming 12 months. Instead we get an omnibus listing of projects under development which will be approved in the next two to three years."

I have my own beef about lack of sunlight. There are two budget languages, "accrual" and "cash". The budget papers are written in accrual (which I think of as French), but Treasury and the government have encouraged us to continue the macro policy debate in cash (English). Trouble is, the government doesn't provide a full English translation. We get the key totals, but not much else, which means that as soon as you start trying to hold the government to account on some specific issue, you run into the language barrier.

When people tried to use the budget papers to establish how much the government saved by abandoning its emissions trading scheme, they were told their figures were quite wrong because they were in French, not English. Then, when people asked for an English translation of budget figures in another part of the debate, the government refused to supply it.

I guess all governments engage in this sort of budgetary obfuscation, but I confess I had hoped for better from that nice Mr Rudd.

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Population fall poses immense new challenges

Peter Costello used to say demography is destiny. Like many of the things he said, that's an exaggeration. But it is going to have a big effect on your future.

Demography is the study of human populations. In principle, it's quite separate from economics. But economists are likely to be saying a lot more about it - and boning up on it - because demographic change will have a big effect on the thing they care about most: the growth of the economy.

Actually, as you realise when you read the article by Jamie Hall and Andrew Stone in this quarter's Reserve Bank Bulletin, demographic change has always had a big effect on the growth in gross domestic product.

It's just that, because so far its effect on growth has been positive, we've been able to take it for granted. From about now, however, its effect is likely to be negative, so we'll be taking a lot more notice.

Leaving aside migration (as we will do in this article), the main factor that drives population growth is the fertility rate - the number of babies per woman. (The death rate also matters, obviously, but we'll also take rising longevity as read.)

The world's population has been growing rapidly for most of the past century, thanks to improvements in public health, medical science and economic development. But the global fertility rate has been falling sharply since the end of the postwar baby boom. From five babies per woman it's now down to about 2, thanks to the spread of effective contraception and rising living standards.

United Nations projections foresee the rate falling to two babies per woman by the middle of this century, which is lower than the replacement rate of 2.1 babies.

So the rate of growth in the world's population has been slowing for decades and, while population is expected to continue growing until the second half of this century, it will then start to decline.

Get that: some of our youngsters will live to see the world's population falling. But population decline will start earlier in some countries than others. Indeed, it's already started in Japan and Germany. And it won't be just the rich countries where population is falling.

The growth in a country's output of goods and services (GDP) can be viewed as coming from two sources: growth in the input of labour and improvement in the productivity of that labour. Three main factors determine the growth in the input of labour: growth in the population, growth in the proportion of the population that is of working age, and changes in the rate at which people of working age choose to participate in the labour force. (Again for simplicity we'll ignore changes in the participation rate.)

Over the 10 years to 2005 the United States' average growth in real GDP was 3.3 per cent a year. Turns out that 1.1 percentage points of that growth came from increased population (meaning it did nothing to raise America's standard of living) and 0.2 percentage points came from the rising proportion of the population that was of working age (here assumed to be those aged between 15 and 64).

But now Hall and Stone estimate that, over the 10 years to 2020, the average annual contribution to economic growth from population increase will be a smaller 0.9 percentage points, and the contribution from change in the working-age share will be minus 0.3 percentage points.

In other words, America's average rate of economic growth is expected to be 0.8 percentage points a year (or about a quarter) less, simply because of direct demographic change. The equivalent expected declines in the demographic contribution are 0.6 percentage points for Japan, 0.3 points for Germany and 0.2 points for Italy.

Why is America's loss likely to be greatest? Because demographic change is only now catching up with it. The others have already taken a fair bit of their medicine. It turns out that most of Japan's "lost decade" of weak economic growth is explained by its ageing and now declining population. Without that, its growth was much the same as Germany's.

So far we've tended to think of slow-growing or falling population as an issue purely for the developed countries. But Hall and Stone demonstrate that the coming decade will see demographic change making a reduced contribution to growth throughout Asia.

What's more, China's population will start to fall slowly in about 20 years' time and South Korea's population will peak in 10 year's time and then fall quite rapidly.

Looking again at the 10 years to 2005, China's economic growth averaged 8.8 per cent a year. Of this, 0.8 percentage points came from population increase and 0.6 percentage points from a higher working-age share.

Over the coming 10 years, however, Hall and Stone estimate that population's contribution to growth will slow to 0.6 points a year and the working-age share's contribution will be minus 0.3 per cent. So demography's contribution to growth will be 1.2 points a year lower than in the previous period.

Now take Korea. Demography contributed 0.7 percentage points to its average economic growth of 4.4 per cent a year in the first period, but will make a zero contribution over the coming decade.

The general story for east Asia (the five main ASEAN countries plus Korea, Taiwan and Hong Kong, but excluding China and Japan) is that demography's contribution of 1.8 percentage points (or almost half) during the 10 years to 2005 will fall to 1 percentage point in the coming decade.

But two Asian countries stand out from this general picture of demographic change making a significantly reduced contribution to economic growth over the next 10 years. Population growth in Indonesia and India will be slowing, but still relatively strong.

So the demographic contribution in Indonesia will slow only from 1.9 percentage points a year to 1.2 points a year. In India it will slow only from 2.2 points a year to 1.6 points.

Much of the demographic difference between China on one hand and India and Indonesia on the other would be explained by differences in population control policies, particularly China's one-child policy, which is about to really make its presence felt. (The main explanation for Korea, I suspect, is simply rising affluence prompting people to have fewer kids.)

But however it's explained, the likelihood is that, in about 2030, India will overtake China as the most populous country. So rest assured, economists will be saying a lot more about demography in coming years.

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Wanted: some belief in a leader

As I lay in bed one freezing morning lately I wished it would rain so I wouldn't have to get up and go jogging. But it's a free country - if I disliked the idea of going out into the cold so much, why didn't I just stay in bed? Because I knew if I wanted to be fit there was a small sacrifice involved. I also knew that when I make an effort I feel better than when I don't. All of us make similar decisions every day.

There's no law against wanting to have your cake and eat it - which is just as well because people do it all the time. This, I suspect, is a big part of Kevin Rudd's problem. When Tony Abbott began worrying people by branding the emissions trading scheme a great big new tax on everything and the public's enthusiasm for action on climate change began to slip, Rudd assumed we'd all be quietly relieved when he dropped the idea.

Instead, he's been amazed to discover that decision caused him to drop hugely in our esteem. Why? It's just a case of us wanting to have our cake and eat it. We wanted to worry about what the trading scheme might do to our cost of living but we also wanted action to reduce climate change.

Of course, we also wanted a leader who believed in things and would stick to his guns. A leader we could respect. A leader who, if he went on and on about something being really important, wouldn't just ditch it when the going got tough.

A big part of Rudd's problem is inexperience. As a result of that inexperience and bad advice he has seriously underestimated the electorate. He thought he could stay popular by appearing to pander to our whims.

Turns out we have no respect for a leader who merely gives us what we say we want. Somewhere inside us there is a semi-conscious understanding - probably born of our experience as children - that we need a leader who sometimes imposes on us things we don't fancy but he knows are for our own good.

The tyro politician's error is to assume success is simply about

never telling us anything we don't want to hear. That's the appearance but there's a deeper and more complex reality.

In the months before the 2007 election, Labor's focus groups detected public dissatisfaction over the rising cost of living. Rudd tried to capitalise on this disaffection by expressing great concern about the issue

and implying - without actually promising - there was something he could do about it.

This was the origin of two of the early setbacks in Rudd's term as Prime Minister, the failures of Fuel Watch and Grocery Watch, the first bits of evidence fostering the public's growing (if unfair) conviction that Rudd is all talk and no action.

Guess what? If you conduct focus groups today you'll find much dissatisfaction over the rising cost of living. It is, I suspect, an almost permanent state. The cost of living is always rising - but so too are wages and pensions. We have genuine cause for complaint only when the rise in prices is outstripping the rise in our incomes. And though that happens from time to time, over the past 10 or 15 years wages have grown a lot faster than prices.

So our unceasing complaint about the rising cost of living - always changing its focus, from the cost of petrol to interest rates to the price of electricity - is just another case of us wanting to have our cake and eat it. We wish we lived in a world where prices never rose but incomes rose as they do now. Dream on.

Our problem is not with the rising cost of living but with our efforts to keep up with the rising standard of living. We worry about every price rise because, in our unceasing attempt to keep up with the Joneses (who strive to keep up with us), we over-commit ourselves. When you spend all your income - perhaps more than your income - you always feel poor, always have trouble making ends meet, no matter how high your income.

Politicians who imagine this kind of foolish selfishness defines the electorate underrate us. We're looking for politicians who, in their concern to protect and advance our interests, demand more from us.

Rudd thinks we went cold on his emissions trading scheme because his opponents gave us an exaggerated opinion of what it would do to our cost of living. But Hugh Mackay, the noted social researcher, has a roughly opposite take: having been convinced by Rudd and others that our greenhouse gas emissions need to be reduced, we expected to be asked - even compelled - to change our behaviour.

When cities were running out of water, we had to stop using water in certain ways. Few resented this and almost all complied. The more we complied the more convinced we became of the seriousness of the problem and the need for strong action.

With climate change, however, no immediate demands were made on us. This was partly because of Rudd's misguided fear that making demands on us would make him unpopular.

Mackay makes the psychologist's point that our changes in attitude don't last unless they're quickly and strongly reinforced by a change in our actions (a truth that doesn't fit easily with economists' aversion to moralising, compulsion and even voluntary action, in favour of mere changes in prices).

Now, thanks to his great misstep in abandoning his trading scheme, Rudd lacks the moral authority to be believed even when he assures us the mining companies' claims that the resource tax would damage the economy are self-serving scaremongering.

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What would Jesus do about economic growth?

Should Christians support capitalism? According to a leading English layman, despite all its material benefits, capitalism as we know it contains moral flaws with serious social consequences.

I'm in no position to preach to Christians, but I'm happy to pass on the views of Dr Michael Schluter, founder of Britain's Relationships Foundation, which will be of interest to a wider audience (and can be found at www.jubilee-centre.org/resources.php?catID=1).

Schluter's beef is against the failings of capitalism that arise from corporations, which have developed as its primary engine.

His starting point is the belief that God is a relational being, whose priority is not economic growth, but right relationships between humanity and himself and between human beings. Christ's injunction to "love God and love your neighbour" points to the priority of relational wealth over financial wealth because love is a quality of relationships.

Corporate capitalism's first moral flaw, he says, is its exclusively materialistic vision. It rests on the pursuit of business profit and personal gain. It promotes the idolising of money, which Jesus calls "Mammon".

"People are regarded by companies as a resource, or as a cost in the profit and loss account, devoid of relational or environmental context. So capitalism constantly has to be restrained from destroying the social capital on which it depends for its future existence," he says.

This focus on capital lends itself to the idolatry of wealth at a personal level, and the idolatry of economic growth at a corporate and national level. Shareholders pursue personal wealth with little knowledge of how it is generated, and senior management with scant regard for pay structures at lower levels of the company, while customers are persuaded by advertising to pursue self-gratification in its many forms.

Corporate capitalism's second moral flaw is that it offers reward without responsibility. In the Parable of the Talents, Jesus implies that gaining money through interest on a loan is "reaping where you haven't sown". Lenders may accept some small risk, but they accept no responsibility for how or where the money is used.

Debt finance generally results in relational distance rather than relational "proximity" because the lender generally has no incentive to remain engaged with, or even in regular contact with, the borrower.

In the workings of large corporations, shareholders generally have little say in decision-making. Most investors provide share capital through a financial intermediary, such as a pension fund. Often they don't know or care in which companies they hold shares. Even the financial intermediaries generally do little to influence company policy.

Perhaps, Schluter says, instead of "no taxation without representation" we should adopt the slogan "no reward without responsibility, no profit without participation".

Corporate capitalism's third moral failing arises from the limited liability of shareholders, which allows debts to be left unpaid where the company becomes insolvent. Worse, the unpaid creditors are often employees, consumers and smaller companies supplying goods and services.

Because the downside risks of borrowing are capped, while the upside risks aren't, management has been willing to borrow huge sums relative to the company's share capital and thus expand companies at a frantic pace.

In the finance sector, incentive schemes often reward risk-taking excessively on the upside with no downside penalties, reflecting the risk position of shareholders. Consequent mega-losses have to be financed by taxpayers to limit wider economic fallout.

Schluter's fourth charge against corporate capitalism is that it disconnects people from place. In the Old Testament, the jubilee laws required all rural property to be returned free to its original family owners every 50th year.

This ensured long-term rootedness in a particular place for every extended family. A byproduct was to ensure a measure of equity in the distribution of property, which ensured a broad distribution of political power.

By contrast, capitalism regards land and property as assets without relational significance. This greater flexibility and mobility undoubtedly bring material benefits. But as extended family members move away from one another, and communities become more transient, they can no longer fulfil welfare roles.

Grandparents can no longer help look after grandchildren, and responsibility for care of older people and those with disabilities falls on the state, with the costs having to be met from tax revenues.

Schluter's final charge is that corporate capitalism provides inadequate social safeguards. It has no concept of protecting the vulnerable through constraints on the market. Deregulation limits constraints on consumer credit although the devastating consequences of debt for personal health and family relationships are well known.

Deregulation ensures labour is available for hire 24 hours a day, seven days a week, whereas biblical law protected a day a week for non-work priorities including rest, worship and family.

The adverse consequences of these flaws start with family and community breakdown. "The greater wealth of some sections of society in capitalist nations has to be set against the greater 'relational poverty' which extends to an ever greater proportion of the population. The danger is that over time these relational problems become self-reinforcing and self-replicating," Schluter says.

Another consequence of capitalism's failings over the longer term is a huge growth in government spending. As the number of damaged households increases, so does the size of the bureaucracy.

Government spending on welfare has reached a level many regard as unsustainable, Schluter argues, yet without it many vulnerable people would have little or no physical or emotional support.

As state agencies take over many of the roles of family and local community, they undermine the reasons why these institutions exist and thus further lower people's loyalty and commitment to them.

Schluter's conclusion is that Christians need to search urgently for a new economic order based on biblical revelation.

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The economy's animal spirits

John Maynard Keynes first recognised it when seeking to explain why the Great Depression happened even though the economic theory of the time said it couldn't. But it's taken the global financial crisis to help us rediscover that truth: the main reason economies fluctuate as they do is the changing psychology of the people who compose the economy.

Keynes called this our "animal spirits", which is the title of a book by George Akerlof, a Nobel laureate in economics, and Robert Shiller, a leading proponent of behavioural finance.

Why isn't Keynes widely recognised for what he was: the first behavioural economist? Because his followers - notably Sir John Hicks, another Englishman - quickly suppressed that part of Keynes's explanation for the Depression in their efforts to make Keynesian thinking more acceptable to economists steeped in the neo-classical assumption that economic actors (you and me) always act rationally (with carefully calculated self-interest) and never emotionally or instinctively.

Hicks and others preferred to explain the Depression by means of the newly invented Keynesian "multiplier" so they could do what they thought mattered most, win support for Keynes's key policy prescription: the use of government spending to stimulate demand when it was deficient.

These days, the term animal spirits is usually used to refer to business and consumer "confidence", as measured by, for example, the Westpac-Melbourne Institute index of consumer sentiment and the NAB survey of business confidence.

But Akerlof and Shiller point out that "animal" means "of the mind" or "animating". So they take the term to refer to all our non-economic, non-rational emotions and motivations. Their point is that though these motivations have been defined as non-economic (and thus have been excluded from the conventional, neo-classical model of the economy), that doesn't stop them having a considerable influence over our economic behaviour.

The truth is that, even with a multiplier built in, the neo-classical model can't explain why market economies have always moved in cycles of boom and bust. It simply assumes the economy is always at full employment. But the changing moods and attitudes of the humans who make up the economy can explain the business cycle.

Akerlof and Shiller acknowledge confidence as the cornerstone of animal spirits, but argue they have four other components: fairness, corruption and bad faith, money illusion and stories. These other elements are needed to adequately explain the economy's ups and downs, and catastrophic events such as the global financial crisis.

Conventional economics assumes that when businesses or individuals make significant investment decisions they consider all the options available to them and all the possible monetary outcomes, they attach probabilities to each outcome, multiply the two together and then add them up to get the "expected benefit". If it's high enough, they go ahead with the project.

But often the probabilities are no more than educated guesses. So whether the project goes ahead often depends on how confident people feel about the prospects for the economy and their project, whether they're in an optimistic or pessimistic mood.

Concerns about fairness are excluded from the conventional model, but not from the motivations of economic actors. Questionnaires show most people regard it as unfair for a business to raise the price of umbrellas on a wet day (a behaviour economists regard as rational), but fair for it to raise prices when its costs have increased.

Sociologists tell us there are behavioural "norms" that describe how people think they and others should behave in particular circumstances. We get angry when people fail to conform to norms and this anger may have adverse consequences for businesses.

One area where perceptions of fairness are very much to the fore is in the setting of wages. Workers get angry when there's any suggestion of their wages being cut (even though they may well accept a fall in their real wages if economic conditions seem to warrant it).

Employers' inability to cut nominal wages when there's a fall in the demand for their product means downturns in the economy lead to more unemployment than they would if wages and prices were more flexible (as the model assumes).

Most recessions involve corporate corruption scandals and instances of "bad faith" (people behaving in ways that are unethical but not illegal).

The business cycle is connected to fluctuations in personal commitment to principles of good behaviour and to fluctuations in predatory activity, which in turn is related to changes in opportunities for such activity.

"Money illusion" means people base their economic decisions on "nominal" monetary amounts, failing to allow for the effect of inflation. But one of the most important assumptions of modern economics (where "modern" means it has reverted to the neo-classical assumptions that prevailed before the Keynesian revolution) is that people always see through the "veil" of inflation and compare prices in real terms.

The obvious truth is that sometimes people allow for inflation and sometimes they don't. Or, they do to an extent, but not completely. If so, this causes them to behave in ways contrary to those predicted by the conventional model.

The human mind is built to think in terms of narratives, of sequences of events with an internal logic and dynamic that appear as a unified whole. And much human motivation comes from living through a story of our lives that we tell ourselves.

The same is true for confidence in a nation, a company or an institution. Great leaders are first and foremost creators of stories.

High confidence tends to be associated with inspirational stories, stories about new business initiatives, tales of how others are getting rich.

"New era" stories (such as that the internet has brought us to a new era of profit and prosperity) have tended to accompany the major booms in sharemarkets around the world.

So ends Akerlof and Shiller's list of all the main "non-economic" things that are in our minds and that influence our economic behaviour, but aren't in the conventional model.

"If we thought that people were totally rational, and that they acted almost entirely out of economic motives, we too would believe that government should play little role in the regulation of financial markets, and perhaps even in determining the level of aggregate demand," they say.

"But, on the contrary, all of those animal spirits tend to drive the economy sometimes one way and sometimes another. Without intervention by the government the economy will suffer massive swings in employment.

"And financial markets will, from time to time, fall into chaos."

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NSW budget: Staying on target needs steady hands

So far, so good. A government on its last legs, with everything - and nothing - to lose, has delivered a responsible budget.

Of course, whether the good guys within the Keneally government can keep holding the line against crazy, panic-stricken decisions until election day is another matter.

The Treasurer, Eric Roozendaal, can - and does - boast a return to budget operating surplus two years earlier than expected, with the surplus for the coming financial year forecast to swell to $770 million and $890 million the year after.

In truth, the credit for this goes primarily to the economy itself. What went down has - predictably - come back up. If any particular politicians deserve to share the credit it is Kevin Rudd and Wayne Swan with their huge and timely fiscal stimulus (not forgetting the role of the central bankers in slashing interest rates).

Actually, the flow of federal stimulus money through the state budget has the effect of overstating the improvement in the state's budgetary position. A better measure is given by the Keneally government's annual "net borrowing" (which includes its considerable spending on capital works).

After borrowing $3.3 billion in the recession year of 2008-09, the government expects to borrow $3.8 billion in the financial year just ending, falling to $3.3 billion in the coming year and to $1.5 billion the year after.

Borrowing to finance worthwhile public infrastructure is no crime, particularly if a high proportion of the total capital spending is financed from the government's own funds, including the operating surplus.

The budget papers show that whereas only 38 per cent of the capital works program was financed from internal sources in 2008-09, this is expected to rise to almost half in the year just ending, to 57 per cent in the coming year and to more than three-quarters in the following year.

This is the justification (and explanation) for Roozendaal's claim to be "strengthening the state's balance sheet", along with the decision to use the proceeds from the sale of the Lotteries Office to reduce the government's unfunded superannuation liability.

It's just a pity the same commitment hasn't been given on the use of the proceeds from the pending sale of the electricity distribution companies and other businesses.

When you strip out the effect of federal stimulus money, total budget revenue is expected to grow at an average rate of 5.7 per cent a year over the next four years, compared with average growth in expenses of 4.7 per cent a year.

This, too, is evidence of responsible budgeting, particularly the control of spending growth. It suggests the governments better services and value plan, the announcement of which last year drew much scepticism (including from yours truly), is having some success in limiting growth in public sector wage sand controlling administrative costs.

But with a new round of wage negotiations coming up with the nurses, Kristina Keneallys pre-election nerve will be tested. Protect Labors reputation for cautious budgeting, or buy popularity with the nurses (and other government employees riding on their coat-tails) in the knowledge that, if it fails to do the trick, the bill will be left to your opponents?

The highlight of the budgets new measures is its strategy to increase the supply of new homes by reducing local councils developer charges and offering a temporary incentive for people to buy apartments off the plan.

This a welcome and generally well thought through initiative.

Unfortunately, thes ame cant be said of the decision to increase the already planned reduction in payroll tax, in response towrong-headed pressure from business lobby groups (which use their influence to favour big business at the expense of small- to medium-sized businesses)and an expedient opposition (which will see the light the momentits bum hits th eTreasury benches).

As economists never tire of trying to drum into the thick skulls of business people and politicians, the claim that payroll tax is a tax on jobs is spurious.

The same could be said of many taxes, including the goods and services tax and even income tax.

Nor does Roozendaal get a tick for his wasteful spending on investment attraction (read: competing with other states to have foreign companies play them off for a break, then setup where they were going to go anyway).

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At last a strategy that will ease the housing shortage

It has taken Australians a long time to twig that rapidly rising house prices aren't as good as they sound. For ages home owners happily imagined higher prices made them richer. But richer in what sense?

For a start, you can't get your hands on that wealth unless you're prepared to trade down to a smaller or cheaper place. You can borrow against it, but what's so great about that? You still have to pay interest - and pay back the principal. Should you wish to trade up to a bigger or better place, the price has gone up for you as much as for anyone else. Exactly how are you better off?

Politicians will never tell you this, but economists will: a nation can't make itself richer by contriving to charge itself more for its housing.

All that really happens when house prices rise is a redistribution of wealth. People who own their home are better off at the expense of people who don't. (Even if those people have never aspired to own their home, they'll end up paying higher rent.)

For the most part what we're talking about is a transfer of wealth between the generations. The older generation gains at the expense of the rising generation. Which is fine if you don't have kids. If you do, however, you have to wonder how on earth they'll be able to afford a place of their own. One way they'll manage it - provided there aren't too many of them - is via a generous subsidy from their property-rich oldies.

Oh. See what I mean about in what sense are you richer? As this realisation has dawned, most of us have stopped seeing rising house prices as a great boon (and the pollies have stopped boasting about it).

Since 1995 house prices across Australia have risen about 230 per cent faster than the rate of inflation. That's a real increase averaging about 6 per cent a year (whereas the conventional wisdom was that house prices rose by only 1 or 2 per cent a year in real terms).

Australian house prices are now high even by the standards of other developed countries. Up until the middle of the noughties, the main reason for the increase was the marked fall in interest rates following our return to low inflation.

This allowed people to borrow a lot more for the same level of monthly mortgage payments, so a lot of people decided it was a good time to trade up to a bigger house in a better suburb. Trouble is, when so many people decide that at the same time, all they succeed in doing is bidding up the prices of the limited supply of better-located houses they're fighting over.

Since the middle of the noughties, however, the main cause of house-price rises has changed. High immigration has caused the population to grow faster than the number of homes. As ever when demand outstrips supply, prices rise.

Several years of this have left us with a chronic and growing shortage of dwellings. We seem to have trouble building more than about 155,000 homes a year. Allow for the homes we pull down each year, and for the proportion of holiday homes built, and this shrinks to about 133,000 a year.

According to the estimates of the federal government's National Housing Supply Council, at June last year we had a nationwide shortage of 178,000 dwellings. It estimates by the end of this month this will have increased to 202,000 (but don't be surprised if it's higher). NSW accounts for almost a third of the shortage.

With the business community and the Rudd government keen to maintain high levels of immigration, you can see why the housing shortage is becoming a matter of great concern.

The problem seems to be blockages in state and local government planning and approval processes, which limit the amount of new land being made available and built on. A related problem is the reluctance of many councils (under pressure from their voters) to approve medium- and high-density "infill".

NSW in particular has had a problem with exorbitant developer charges, which made newly released land unaffordable to young couples.

But here's the good news: yesterday's state budget introduces an impressive "comprehensive housing supply strategy" that looks like it really will increase the supply of new homes coming on to the market and thus limit the upward pressure on house prices.

In 2008 the government reduced its own "state infrastructure charges" on developers from about $46,000 to $11,000 a lot. Now it's imposed a cap of $20,000 a lot on local council charges, which at present can be as high as $50,000 or $60,000 a lot.

All council developer charges will have to be approved by the NSW Independent Pricing and Regulatory Tribunal, which will only permit passing on of infrastructure costs essential to the development sites, not general community betterment projects. This suggests some councils' charges may be lower than the $20,000 cap.

One reason councils have been so savage in imposing developer charges is the long-standing practice of pegging their rate increases to the consumer price index, which has left them with insufficient funds to finance needed capital works.

Now the rate-pegging process is to be handed over to the tribunal, which will develop a more realistic local government cost index and consider councils' requests for higher rate increases.

The government will spend $44 million over two years to speed up the planning and approval process and ensure more weight is given to economic concerns. Almost half that will reward councils that process more development approvals. Much of the rest will allow the Department of Planning to accelerate its implementation of reforms.

If ever there was an area where NSW needed to lift its game, this is it. And now, remarkably, it has.

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How Keynes, not mining, saved us from recession

You never judge economists by whether they get their forecasts right. They rarely do. But they score points in my book if they're willing to work out why they got them wrong - and make the results public.

This is what Treasury's chief forecaster, Dr David Gruen, did in a speech to the Economic Society in Sydney on Friday.

I don't hold out much hope that such exercises will help produce better forecasts in future. But they should deepen our understanding of how the economy works.

Gruen's examination of Treasury's record in forecasting real gross domestic product over the past 21 years finds there's no upward or downward bias in its errors, but its "mean absolute percentage error" is 0.93 percentage points.

When you remember the trend rate of growth is about 3.25 per cent a year, that's a high degree of error.

Last May Treasury forecast that real gross domestic product would contract by 0.5 per cent in the financial year just ending, the first time it had ever forecast "negative growth". The year isn't over yet, but the revised forecast in this year's budget is positive growth of 2 per cent. And just the first three-quarters of the financial year are showing average growth of 1.9 per cent.

But if you think all that's bad, just remember: the smarties who purport to know better than Treasury are usually worse. Consider these reactions to the forecasts in last year's budget.

Des Moore, the climate-change denying activist: "The Rudd government's budget paints an unbelievable picture of a very mild recession (only a 0.5 per cent fall in GDP next year) followed by a recovery of 2.25 per cent in the election year (2010-11) and an above-trend rate of growth of 4.5 per cent in the following year."

John Roskam, a leading libertarian: "If Prime Minister Kevin Rudd genuinely believes Treasury is conservative when it forecasts economic growth of 4 per cent within two years, then it would be interesting to know his definition of optimistic. Treasury officials are not used to being laughed at on budget night but, as soon as their growth forecasts were revealed, no other reaction was possible."

Of course, we do know that average growth in real GDP in calendar 2009 was 1.3 per cent, and Gruen has revealed Treasury's unpublished forecast of minus 0.9 per cent. This was worse than the mean of minus 0.6 per cent for 17 private sector forecasts gathered by Consensus Economics, but right on the median.

After allowing for imports and inventories, the largest contribution to growth came from consumer spending (1.4 percentage points), followed by public sector spending (0.9 points), business investment and exports (0.4 points each), with housing investment making a negative contribution of 0.3 points.

(If you're wondering how all that adds up to just 1.3 per cent, it does so with the help of a negative contribution of 1.5 points from the "statistical discrepancy". Don't groan - the national accounts are like that; it's just one of the complications forecasters face.)

It's clear most of that surprisingly strong performance was due to old-fashioned Keynesian fiscal stimulus. Consumer spending was greatly bolstered by the cash splash, while the jump in public sector spending speaks for itself. The growth in business investment was explained by the draw-forward effect of the temporary tax break.

According to Treasury's estimates, the fiscal stimulus contributed about 2 percentage points to the overall growth of 1.3 per cent last year, meaning that, without it, GDP would have contracted by 0.7 per cent.

So much for the claim the mining sector was "a key factor in keeping Australia out of recession".

If you decompose exports' contribution of 0.4 percentage points, rural commodities contributed more (0.3 points) than mineral commodities (0.2 points), with manufactures making a negative contribution.

Treasury did allow for the effect of the fiscal stimulus in its forecast, but it's pretty clear it (and everyone else) didn't allow enough.

Gruen believes it took insufficient account of the "favourable feedback loop that expansionary macro-economic policy - both monetary and fiscal - appears to have generated".

"Macro-economic policy appears to have been large enough and quick enough to convince consumers and businesses that the domestic slowdown would be relatively mild," Gruen says.

"This, in turn, led consumers and businesses to continue to spend, and led businesses to cut workers' hours rather than laying them off which, in turn, helped the economic slowdown to be relatively mild."

The turnaround in business and consumer sentiment began earlier and was a lot stronger in Australia than in other developed economies. But that's another problem for the forecasters: swings in the collective mood are probably the biggest factor driving the business cycle, but how do you predict them?

It's true, of course, that continuing demand from China played a part in keeping us afloat. Gruen notes that the Consensus forecast for "non-Japan Asia turned out to be significantly too pessimistic".

But why? Partly because the forecasters made insufficient allowance for the Asians' lack of impairment in their financial systems, but also because they underestimated the speed and size of the fiscal and monetary stimulus, particularly in Korea and China.

As well as underrating the power of Keynesian policies - which are likely to be more potent in the young and dynamic emerging economies - too many forecasters failed to see how much success the Chinese would have in switching from external demand to domestic demand, particularly spending on infrastructure.

An economy as big as China has plenty of scope to "decouple" from the developed countries - a point worth remembering when you're tempted by the latest fear, that Europe's problems will wipe us out.

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