Productivity, or a future paved with gold?

Economists are convinced our highest priority is to keep increasing our material standard of living as rapidly as possible. I'm not sure they're right. But if they are, we have a problem.

There are three ways for a country to get richer, to raise its real income (gross domestic product) per person. The first is to keep increasing the labour and physical capital being used to produce goods and services at a faster rate than the population is growing.

The second way is to be lucky enough to have the rest of the world pay us higher prices for the stuff we sell it.

The third way is to increase our productivity - to find ways of producing more goods and services each year from the same quantities of labour and capital. We achieve this mainly through technological advance.

Trouble is, we've got problems with two out of three of these - and the third can't last.

We used to have no trouble increasing the total number of hours we worked faster than the population was increasing, but the ageing of the population means we won't be able to keep this up.

Not to worry. The world is paying us more for the stuff we sell it, particularly our coal and iron ore. Hugely more. That's why we have been getting a lot richer for most of the past decade. Unemployment has been falling and wages and other incomes have been rising faster than prices.

But this is the bit that can't last. The prices we're getting for our exports of coal and iron ore can't keep rising from their present stratospheric heights. And sooner or later they will fall back to more reasonable levels.

Now, none of this would matter all that much if we were going OK on productivity improvement. Productivity improvement through continuous technological advance is actually the bedrock of material living standards, which in the developed countries have been rising continuously since the industrial revolution.

This is the magic of the capitalist system. Every year we get a little bit more efficient and a little bit richer. Only when you're as old as I am can you look back and realise that these days we're a lot smarter about the way we do things than we used to be.

But here's the problem: over the past decade there has been a dramatic deterioration in Australia's productivity performance, with the broadest measure of productivity actually getting worse over the past five years.

Why haven't you heard about this major reversal? Because its effect on our pockets has been concealed by all the extra income flowing in from China and our other trading partners. But that's what can't last.

This remarkably under-remarked story is revealed in a report issued this week by Saul Eslake and Marcus Walsh of the Grattan Institute, Australia's Productivity Challenge.

Eslake reminds us that, whereas in the 1990s real GDP grew at an average rate of 3.4 per cent a year, with improvement in the productivity of labour accounting for 60 per cent of that growth (2.1 percentage points a year), in the noughties GDP growth averaged 3.1 per cent a year, with labour productivity improvement accounting for only about 45 per cent (1.4 percentage points a year).

But it's actually worse than that because the average for the noughties conceals a steady decline over the course of the decade. Whereas the annual rate of improvement in labour productivity kept increasing over the '90s to reach a peak of 2.8 per cent a year during the five years ended 2001-02, since then it has slowed continuously, reaching a low of just 0.8 per cent during the five years ended 2008-09.

One way to increase the productivity of labour is to give workers more machines (physical capital) to work with. And we did a lot of that during the noughties.

So if we switch from looking at the productivity of labour to looking at the productivity of labour and capital combined (known as ''multi-factor productivity''), we find it has actually been going backwards since the mid-noughties.

Why haven't we heard a lot more about this remarkably poor performance (which, as you can see, began long before the Rudd government came to office)? Mainly because it has been concealed by the riches of the resources boom, but also because the econocrats have argued it's the product of special, temporary factors in a couple of sectors.

The mining sector, for example, has been spending on a huge expansion of its production capacity, but a lot of the extra production hasn't yet come on line. So, arithmetically, its productivity performance has been appalling.

Then if you look at utilities - electricity, gas and water - you find that, after neglecting to invest in increased production capacity to keep up with population growth, in the noughties governments have had to invest heavily (including in five new desalination plants), installing capacity that won't all be used until the population has grown further.

Finally, the output of the agricultural sector has been hard hit by drought over the past decade, wrecking its productivity figures.

The econocrats have argued that these three problem areas are sufficient to explain the deterioration in our productivity performance overall.

But Eslake disputes this, producing new figures to show there has been a substantial deterioration in overall labour productivity growth even when mining and utilities are excluded.

He argues ''it may be dangerously complacent to assume that the decline in productivity growth over the past decade will be automatically reversed at some point during the coming decade''.

So how does Eslake explain the decline? By the absence of further significant micro-economic reform during the noughties (compared with the big payoff from earlier reform during the second half of the '90s), but also by an increase in ''productivity-stifling legislation and regulation'', much of it in pursuit of ''national security'' (in the aftermath of the terrorism attacks on September 11, 2001) and improved standards of corporate governance (following a series of corporate scandals in the US and Australia).

But Eslake also blames the ''paradoxical downside of economic success''.

We have managed to keep the economy growing strongly for a record period since the recession of the early '90s, but this may have sapped our enthusiasm for further reform as well as permitting firms to be less vigilant in their pursuit of higher productivity. Finally, the return to near full employment permitted by the long expansion phase has led to productivity-reducing shortages of skilled labour and bottlenecks in transport and other infrastructure.

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Floods expose national loss of respect

It's a pity Julia Gillard announced her flood levy after Australia Day rather than before it. Instead of spending the day telling ourselves what wonderful people Aussies are, we could have reflected on our darker side - why we're developing a Jekyll and Hyde personality.

As many acts of minor and major heroism during the Queensland floods have reminded us, Aussies are good people to be around in times of crisis.

We rise to the occasion; we pull together. If we're on the spot and see someone in difficulties we'll do all we can to help them, then look around for anyone else who needs helping.

Even if we're not personally involved, even if all we know of the disaster comes to us on the TV news, our hearts go out. We yearn to contribute towards the needs of those poor sods. Sling $20 or $50 into a bucket for the Premier's Relief Fund? Think nothing of it.

But ask the better-off half of us to pay a temporary tax levy to help fund the rebuilding, which will cost only the wealthiest among us more than $5 a week, and all hell breaks loose. Suddenly, we can think of half a dozen reasons why we shouldn't have to pay.

I've already donated - why are you coming back for more? If you compel people to pay, fewer will donate. I pay too much tax already, why are you hitting me again? Why can't you just cut some of all that wasteful government spending? Why are you so obsessed with balancing the budget - why can't you just add the cost to the deficit? Don't you realise how much the cost of living's rising?

They sound like reasonable arguments but, in truth, we just don't want to pay no matter how worthy the cause. Why such a change of tune? Because the government got involved. When we thought it was personal - I give my time or money to help other people in need - that's fine.

But introduce the government and it all becomes impersonal and amorphous. The link between me and my money and the people it will help is broken. The government's budget is a vast, bottomless pit. Why ask me to throw more money into it? Surely there's someone earning far more than me who should contribute? And, in any case, what about all the money you're already wasting?

Many objectors don't seem to have paused long enough to learn that their donations go to helping individual families who've suffered loss, whereas the levy will go towards rebuilding public "infrastructure" - otherwise known as roads, bridges and ports.

So alienated have we become from the work of government we regard it as a giant soft cop - a magic pudding, where the idea is to take out as much as possible ("I've paid taxes all my life ...") and put in as little as possible. How is this circle squared? Who knows, who cares?

But there's more to this affair than just our pathological objection to paying more tax. It's a dramatic demonstration of the way Australians are losing the ability to fall in behind a leader.

All of us know the nation's problems won't be overcome without decisive leadership. We regularly bewail our politicians' lack of courage and conviction, their reluctance to risk their personal survival in the country's best interests.

Yet we give our leaders so little loyalty. The announcement of a government decision is taken as the occasion for the outbreak of dissent. All those with a reason for objecting cry out and their criticism is amplified by the media, whereas those who agree fall silent. No one feels obliged to actively support the leader, even if just because she is our leader and someone has to accept ultimate responsibility for deciding what we'll do and how we'll do it.

Of course, no one wants to live in a country where the leader's will is never challenged. We each have the democratic right to oppose all government decisions by all legal means. But we also have the democratic right to support, defend or even just acquiesce in the judgment of the people we elected to lead us.

Why are we becoming so much more prone to arguing the toss than falling into line? And how do we imagine making leadership so much more difficult for the leader of the day will leave us better governed? Why are we training our governments to timidity?

Part of the explanation is partisanship - our willingness to put loyalty to party ahead of loyalty to our community and its need for effective leadership. I didn't vote for these people, so I'll regard everything they try to do as illegitimate.

Trouble is, there is little partisanship running the other way. Consider the deathbed bastardry of Labor's own Kristina Keneally in objecting that NSW taxpayers deserve special concessions under the levy.

No, there's more to this than partisanship: there is a general loss of loyalty and respect for whoever is our leader. The government is always and everywhere fair game. Consider the lack of public censure of the Opposition Leader, Tony Abbott, for his utterly obstructive behaviour.

Having narrowly lost the last election, he's behaving like a spoilt child, refusing to support any policy proposed by the government, whether good, bad or indifferent.

His self-righteous opposition to the flood levy and all tax increases is extraordinarily hypocritical, considering he proposed his own special levy in the election campaign and supported at least six temporary levies imposed by the Howard government, not to mention that ultimate "great big new tax on everything" known as the GST.

What he's saying to the nation is: I'll do all in my power to make Parliament unworkable until you make me leader.

Oh yeah, we reply, fair enough.

We have a democratic right to make our country ungovernable - and it seems we're well on the way to doing so.

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Floods' economic pain greatly exaggerated

Most of us are back at work, but the silly season won't be over until we get the Queensland floods into perspective. They are a great human tragedy, but they're not such a big deal for the economy.

It's not surprising the public has been so excited about such amazing scenes and so much loss of life and property. Nor is it surprising the media devoted so much coverage to the floods when, with most of us at the beach, there's been so little other news.

It's not even surprising the Gillard government has been beating up the story, making it out to be the biggest thing since the global financial crisis. At one level this is just the pollies doing their instinctive I-feel-your-pain routine. They could seem heartless if they tried telling people things weren't as bad as they seemed.

At another level it's easy to see Julia Gillard trying to gain the same boost to her popularity as Anna Bligh. She'd be well aware of all the seats Labor lost in Queensland at the election in August. It's an almost inevitable assumption by the punters and the media that if an event is huge in human and media terms it must be just as big in its effect on the economy. When the punters tire of seeing footage of people on roofs, you "take the story forward" by finding some expert who'll agree it also spells disaster for the economy.

The wise and much-loved econocrat Austin Holmes used to say that one of the most important skills an economist needed was "a sense of the relative magnitudes" - the ability to see whether something was big enough to be worth worrying about.

That sense has been absent from the comments of those business and academic economists on duty over the silly season, happily supplying the media's demand for comments confirming the immensity of the floods' economic and budgetary implications.

With the revelation last week of the econocrats' estimates of the likely magnitudes, it's clear the figures supplied by business economists were way too high. And the economists' furious debate over how the budgetary cost of the rebuilding effort should be financed is now revealed as utterly out of proportion to the modest sums involved.

Of course, you still wouldn't have twigged to this had you focused on the government's rhetoric rather than its figures. In Gillard's speech on the budgetary costs and Wayne Swan's speech on the economic impact both were busily exaggerating the size of the crisis, even while revealing how small it really was.

Gillard said it was "the most expensive disaster in Australia's history" and that the "cost to the economy is enormous". The government's task, she kept repeating, was to "rebuild Queensland".

Swan repeated that "this is likely to end up being the most costly disaster in Australian history", which was "going to cost Australia dearly" and involves a "massive reconstruction effort". The closest he got to the truth was his observation that "the economic questions pale into insignificance next to the human cost of what we've seen".

If this is the most expensive natural disaster in Australian history, all it proves is the cost of earlier disasters was negligible. If you can "rebuild Queensland" for just $5.6 billion, it must be a pretty tin-pot place.

If $5.6 billion seems a lot, consider some "relative magnitudes": the economy's annual production of goods and services (gross domestic product) totals $1400 billion, and the budget's annual revenue collections total $314 billion.

Note that, though no one's thought it worthy of mention, the $5.6 billion in spending will be spread over at least three financial years, making it that much easier to fund.

We know that more than a third of the $5.6 billion will be paid out in the present financial year with, presumably, most of the rest paid in 2011-12. So just how the flood reconstruction spending could threaten the budget's promised return to surplus in 2012-13 is something no one has explained.

And if $5.6 billion isn't all that significant in the scheme of things, how much less significant is the $1.8 billion to be raised from the tax levy? The fuss economists have been making about it tells us more about their hang-ups over taxation than their powers of economic analysis.

And how they can keep a straight face while claiming it could have a significant effect on consumer spending (well over $700 billion a year) is beyond me.

Turning from the budget to the economy, Treasury's estimate is that the floods will reduce gross domestic product by about 0.5 percentage points, with the effect concentrated in the March quarter.

Thereafter, however, the rebuilding effort - private as well as public - will add to GDP and probably largely offset the initial dip. So the floods will do more to change the profile of growth over the next year or two than to reduce the level it reaches.

Most of the temporary loss of production will be incurred by the Bowen Basin coal miners. But, though it won't show up directly in GDP, their revenue losses will be offset to some extent by the higher prices they'll be getting as a consequence of the global market's reaction to the disruption to supply.

And despite all the fuss the media have been making over higher fruit and vegetable prices, Treasury's best guess is that this will cause a spike of just 0.25 percentage points in the consumer price index for the March quarter, with prices falling back in subsequent quarters.

So the floods do precious little to change the previous reality that, with unemployment down to 5 per cent and a mining investment boom on the way, the economy is close to its capacity constraint and will soon need to be restrained by higher interest rates.

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It's about China, and steel

You wanna make guesses about what will happen to the economy this year? Here's a tip: forget the floods and take more notice of China.

Australia's business economists have already got the message that China dominates the rest of the world's effects on us, whereas their mates in the money markets are slower on the uptake, retaining their obsession with all things American.

China matters, first, because, with a population of 1.35 billion, it's the most populous country in the world. That gives it 20 per cent of the world's population, making it 11 times larger than Japan.

The second reason China matters is because its economy has been growing so rapidly for so long: an average rate of 10 per cent a year for three decades, meaning it's been doubling every eight years.

This means that, since 1980, it's gone from being the 12th-largest economy in the world to the second-largest. This is measured using "purchasing power parity" - that is, taking account of the fact that one US dollar buys far more in China than it does in the US.

So China's economy has moved from being 9 per cent of the size of America's to about 60 per cent in 2009. The International Monetary Fund is expecting it to reach 90 per cent in 2015. If so, it won't be long before China's the biggest economy.

Of course, this still leaves the average Chinese a lot poorer than the average American. Income per person in China has reached only 18 per cent of American incomes - suggesting the Chinese have scope for a lot more growth yet (provided the world has enough idle resources to make it possible).

When you combine China's huge population with its rapid economic growth you find this growth accounted for a quarter of all the growth in the world economy during the noughties. Get that. America's share of world growth would have been very much smaller.

The third reason China matters so much to us: its economy is in our part of the world and is such a good fit with ours. China needs to buy what we've got to sell, and vice versa.

According to figures from the Department of Foreign Affairs and Trade, last financial year China became both our largest export market and our largest trading partner. Our two-way trade in goods and services grew by more than 18 per cent to $90 billion.

China has been our biggest market for exports of goods for some time but last year it overtook the United States to become our largest market for services as well.

Over the course of the noughties China's share of our two-way trade increased from 5 per cent to almost 18 per cent. Its ascension means Japan is now our second-largest export market. And get this: our third-largest is India.

Our top three imports in 2009-10 were travel ($19 billion), passenger vehicles ($15 billion) and petroleum ($15 billion). But to get back to the point, our top three exports were coal ($36 billion), iron ore ($35 billion) and education ($19 billion).

Why's that the point? Because coal and iron ore are the main things we sell China. Iron ore and coking coal are the main components of steel - and, as part of their economic development, the Chinese are producing huge quantities of steel.

So the well-versed economy watcher needs to know more than a bit about China's steel industry. Its story was summarised by James Holloway, Ivan Roberts and Anthony Rush in an article in the latest Reserve Bank Bulletin.

China is now the world's largest producer and consumer of steel. Ten years ago it accounted for 15 per cent of global steel production; today its share is 45 per cent.

Just how much of a country's gross domestic product is devoted to steel is determined by its stage of economic development. Undeveloped countries don't use much steel and advanced countries aren't very "steel-intensive" because much of their economic infrastructure has been built and most of their growth is coming from expanding services.

In between, however, countries are rapidly industrialising and urbanising. And that's where China is. Remembering its average rate of growth in GDP of 10 per cent a year for the past three decades, its steel production grew at average annual rates of 7 per cent in the 1980s, 10 per cent in the '90s and almost 20 per cent in the noughties.

The Chinese steel industry is highly decentralised, with plants scattered throughout the country and with a small number of large, advanced, state-owned steel makers and a large number of small and medium-sized private firms. The Chinese government's policy is to consolidate the industry, to improve economies of scale and reduce the use of high-polluting facilities.

The industry mainly produces steel directly from iron ore and coking coal using the blast furnace and basic oxygen converter method. This means that, on average, each tonne of steel produced requires about 1.7 tonnes of ore and 0.5 tonnes of coking coal.

China has its own extensive reserves of iron ore, but their ore content averages only about 33 per cent, compared with 62 per cent in Australia and about 65 per cent in Brazil and India, making local ore more expensive. So now more than half the ore used is imported.

Until recently China was self-sufficient in coking coal. But many of its deposits are relatively inaccessible and thus costly to mine. And many of its mines are unsafe. So since 2009 there's been a surge in demand for our coal.

More than half China's annual steel production is used for investment in buildings, structures and machinery. (Total public and private investment spending's share of GDP is a remarkably high 45 per cent - a sign China's in the industrialisation phase of development.)

At least a quarter of steel production is used for manufacturing cars, home appliances and much else. A lot of these would be consumed locally but most are probably exported.

The authors conclude that China's steel-intensive industrialisation phase - and hence its strong demand for our iron ore and coking coal - is likely to continue "over the next decade or so".

One conclusion from this is that the floods' biggest effect on our economy is likely to be the temporary disruption to the Queensland mines' production and export of coal.

Think of China, think of steel; think of Chinese steel, think of Australia making big bucks

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Aged care dilemma: tap homes, or let taxpayers pay

There's a lot more to life than money. But it's money - how much things cost and who will pay for them - that causes many of the arguments in families and most of the arguments in politics. Nowhere is that truer than in aged care.

We all agree that old people must be adequately cared for in their declining years and that governments must ensure this happens. But where does private responsibility end and public responsibility begin? More to the point, how should the cost of care be shared between the individuals involved, their heirs and successors, and the taxpayer?

The scope for duck-shoving - the temptation to push costs off on to someone else, particularly the anonymous taxpayer - is enormous. Trouble is, governments represent the taxpayer. Elected politicians know that if the demands they make on taxpayers get too high or grow too rapidly, they're in trouble.

Unless we're careful, we end up with government paralysis: politicians who aren't game to push more of the costs back on to individuals and their families, but aren't prepared to impose a lot more cost on the taxpayer.

The result is an aged care system that isn't working properly. Where some old people who need care aren't getting it because the government has imposed arbitrary limits on how much it's prepared to spend; where some individuals are getting a much bigger public subsidy than is fair, while others are paying a lot more than is fair, and where institutions are underfunded and the people who work for them are underpaid.

As last week's draft report from the Productivity Commission reminds us, that's where our aged care system is now and where it will stay until we find federal leaders with the courage to stand up to both the duck-shovers and the reluctant taxpayers.

But, actually, the system won't stay as it is for long. The ageing of the population means a lot more people will be requiring aged care in coming years, particularly when the bulge of baby boomers reaches old age.

The commission says there's no way the cost of aged care to federal taxpayers will fail to grow significantly over the years. So, barring the unlikely event of offsetting cuts in other government spending, we will have to pay higher taxes.

We can, however, limit the growth in cost to the taxpayer - as well as alleviating other deficiencies in the present system - by making the system more efficient and requiring greater contributions to aged care costs from those individuals in a position to make them.

What would be fair? The commission starts by dividing the total costs faced by old people requiring care into four categories.

First is the cost of accommodation, which is equivalent to rent or mortgage payments and home maintenance. Next are everyday living expenses, such as for food, clothing, laundry, heating and social activities.

Third is the cost of healthcare, such as nursing, therapies and palliative care. And fourth is "personal care" - the additional costs of being looked after because of frailty or disability.

The commission argues that accommodation and everyday living expenses should be the responsibility of individuals, but with a safety net for people of limited means. (Remember, this is why people receive the age pension. Those ineligible for the pension - or for a full pension - have other, private means to call on.)

The commission argues that health services should attract a universal (that is, non-means-tested) subsidy, as is a key principle of Medicare.

On the cost of personal care, the commission says individuals should be required to contribute according to their capacity to pay, but shouldn't be exposed to catastrophic costs of care. It suggests maximum lifetime payments be capped at $60,000.

We tend to think of the elderly as among the poorest in the community, but that's because we focus on their usually modest incomes. But it's a different story when the focus is on their assets.

The distribution of wealth has been shifting towards older Australians since the mid-1980s, and this trend is likely to continue. It's estimated that, in 2000, the 12 per cent of the population aged 65 and over held about 22 per cent of the total net wealth of households. It's projected that by 2030, the aged's share of the population will rise by 7 percentage points, but their share of net wealth will more than double to 47 per cent.

Where's all this wealth coming from? From the rising value of the family home. The rate of home ownership among the elderly is very much higher than among the rest of us. Yet the value of people's homes is largely ignored when calculating their aged-care charges and subsidies - until the house is sold, when everything changes.

This is what the commission says must change to make the cost-sharing fairer to those oldies who've never owned their homes or have recently sold their home, not to mention working taxpayers who may be far less well placed in the housing market.

Taking account of the value of people's homes in assessing their ability to contribute to the cost of their care - which the commission says should vary between 5 per cent to 25 per cent - would increase the pressure on people to sell their home or at least borrow against it.

It proposes widening the use of accommodation bonds - where money is lent to the care institution interest-free - but with the proviso that the size of bonds reflects the actual cost of accommodation.

Many old people and their inheritance-conscious children will hate the sound of all this. But since even John Howard lacked the courage to impose these reforms, it's doubtful whether Julia Gillard will be game to touch them.

The only trouble is, our treatment of people receiving and providing aged care will continue to worsen until we as a nation are prepared to call a halt to the duck-shoving.

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First of a line of green Treasury bosses

In the olden days you didn't get to be boss of a major company, government department - or this newspaper - until you were in your late 50s or early 60s. You stayed in the job until you reached what was then imagined to be the official retirement age of 65. So whether they performed well or badly, no one spent all that long in a top job.

(Going not that far further back, you didn't get to be governor of NSW, Anglican archbishop of Sydney or editor of the Herald unless you were an Englishman, recruited from the Old Country. Having done your bit in governing the colonies, you retired to the Home Counties.)

These days, top jobs go to much younger people, which means they get a longer go at it - assuming they work out - but have to give it up and let someone else have a turn well before they're old enough to retire.

Dr Ken Henry was 43 when he became secretary to the Treasury in 2001. His five-year term was renewed in 2006, so he's held the job for almost a decade and now it's time to move on. He's likely to take a long break before accepting another job.

Henry is what his present political masters aren't: a believer. Like all his predecessors - and his successor, Dr Martin Parkinson - he's an economic rationalist. He believes in the power of market forces and the need to ensure they're harnessed to advancing the wellbeing of the community. Sometimes they need to be let off the leash, sometimes they need to be channelled, sometimes they need to be introduced to an area where they haven't existed but can be used to improve its performance (though sometimes this is a bad idea).

At a time when our politicians seem bereft of bedrock beliefs and values, and most government departments seem to have lost their compass, it's good to have a central agency with a clear view of what constitutes good policy in the public interest and an unwavering willingness to argue for it.

Henry continued to inculcate the Treasury View among his troops - maintaining their esprit de corps - and within the government.

Parkinson is a macro-economist, but Treasury is no longer involved in the day-to-day management of the macro economy - except to the extent that its secretary is an ex officio member of the outfit that does manage the economy, the Reserve Bank board.

Henry is a micro-economist, and Treasury has more than enough to do urging governments to take a rational approach in all the many markets it has influence over. And nowhere is that need greater than in using "economic instruments" - such as a price on carbon and the trading of water rights - to reconcile the conflict between economic activity and preserving the natural environment.

Henry is an environmentalist (as well as an active defender of kangaroos and wombats). He played an important part in developing the Howard government's plans for an emissions trading scheme, as did Parkinson, and Treasury modelling informed the Rudd government's initial attempt to get a scheme up.

There was a joke that the people running Treasury were greener than those running the Environment Department.

Parko, originally Henry's deputy in Treasury, left to work on trading schemes, taking various senior people with him and eventually being appointed to head the new Department of Climate Change.

Now he'll be succeeded by another Treasury man, Blair Comley. So under Henry, Treasury managed to colonise the environmental departments.

Is Henry "one of the greatest of all Treasury secretaries" as Julia Gillard has said? No doubt. Is he the greatest? He's the greatest in my memory.

Treasury was at its most influential during the term of the Hawke government, but I give the credit for that to our greatest ever treasurer, Paul Keating, a man with a deep understanding of how to obtain and use political power, and who needed a purpose to fight for. Treasury supplied that purpose, affecting his conversion to economic rationalism.

Treasury's highest institutional objective has long been to dominate the economic advice going to the government, and no secretary has been more successful in this than Henry, thanks to the arrival of the deeply insecure Rudd government, which sought to hide behind the authority of the supposedly independent Treasury.

Henry obliged - after all, Treasury is not and never could be independent - and became a key adviser to the prime minister, as well as being appointed to every policy committee worth being on.

That was Treasury's institutional reward, the rent it received for the use of its authority. Henry's personal reward was being allowed to head his own comprehensive review of the federal and state tax system.

Those who condemn the government's cursory dismissal of the Henry report have missed the point. Henry's ambition was to lay out a blueprint for long-term tax reform, which would provide a guide to his Treasury successors and an antidote to political ad-hockery for decades to come.

Tax reform was Henry's first love and he played an important part in all the reforms of the past 25 years. He was the first Treasury secretary to acknowledge the validity and usefulness of behavioural economics.

His tax report would have been better had he made more use of behavioural precepts.

Despite its loss of day-to-day macro management, Treasury - and budgetary policy - comes into its own when recession threatens. Here the micro-economist excelled himself.

He played a central role in the Rudd government's response to the global financial crisis and, learning from the policy errors in the severe recession of the early 1990s, urged Rudd to "go hard, go early, go households".

Most punters will never know it, but many owe their continued employment to that wise advice.

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Take a break and we'll all be happy

Psychologists have a form of treatment for unhappy people called PAT: pleasant activity training.

It's quite simple: you make a list of the things you like doing, then do them more often. It's not as silly as it sounds. We've learnt our brains have one system that controls wanting and one that controls liking. The wanting system tends to dominate the liking system, so we often end up doing less of what we like than we'd like to.

I suspect that's true of taking holidays. A survey conducted by Professor Barbara Pocock of the University of South Australia, as part of the Australian Work and Life Index, found 57 per cent of full-time employees would prefer an extra two weeks' paid annual leave to a pay rise of 4 per cent.

So it seems we like taking holidays (and it sounds like a good idea to me). And yet there's a wealth of evidence that many of us don't take the leave we've already got. A survey conducted regularly by Roy Morgan shows that only about 70 per cent of Australians aged 14 or older intend to take at least one holiday over the next 12 months.

Another survey conducted for Reuters by a global market research company, Ipsos, found that only 47 per cent of Australians expected to use all their annual leave. This was the lowest proportion for any country bar the Japanese, on 33 per cent. By contrast, 89 per cent of the French, 77 per cent of the Brits, 75 per cent of the Germans and even 57 per cent of the Americans expect to take all their annual leave.

Australia's governments have required employers to provide their workers with paid annual leave since 1941. In 1973 it was increased to four weeks. At the time many people thought this extravagant, but it's about average. The French get six weeks, while the Finns, Norwegians and Swedes get five.

Pocock's survey shows 60 per cent of Australian employees stockpile at least some of their annual leave. And according to calculations by Roy Morgan, the stockpile has reached 117 million days.

But if people like annual leave, why don't they take it all? According to Pocock's survey, 31 per cent of full-time employees say they're too busy at work and 13 per cent say they couldn't get time off that suited them. Nine per cent say they prefer to work.

And 41 per cent say they're saving their leave for a future holiday - though I'm not sure I believe it. If it were true - if people were merely delaying their holiday-taking - unused leave wouldn't have piled up the way it has.

It may be that some young people want to combine a few years' leave for an extended overseas trip, but I think "saving for later" is just something you say when you don't get around to taking it all.

I guess it's true that, consciously or unconsciously, some employers don't encourage their workers to take their leave, especially key employees.

But is all this a problem? Why turn unused leave into another crisis? Well, a lot of employers think it is a problem, including one quite close to me. If an employee takes all her leave during the year, the business suffers an expense of 52 weeks' wages on her behalf. But if she works all year without taking leave, the expense rises to 56 weeks' wages, with the extra four weeks of untaken leave owing to her adding to the firm's liabilities. (What's more, the firm doesn't get a tax deduction until the leave's actually taken.)

In theory, insisting that everyone take their leave during the year means the firm has to employ more people. In practice, it means we all have to work a bit harder when we're not on leave to cover for those of us who are. Whistle-blowing economists call this "work intensification" - but it comes from employer penny-pinching, not from the leave itself.

Another group that sees untaken leave as a great problem is Tourism Australia, the federal government's tourism marketing body. Last year the minister, Mar'n Fer'son, launched a campaign called No Leave No Life to encourage us to take our leave and spend it in Australia, complete with commercial TV show.

Tourism Australia can think of many reasons why it's good to take your leave (and for employers to offer a "leave-friendly workplace"). Achieving work-life balance, we're told, comes with improved physical and mental well-being.

Taking your leave helps you avoid the stress of exhaustion and burnout. You get greater job satisfaction when you approach your task in a refreshed state. Taking leave helps you "rediscover your friends, your family and most importantly yourself".

The figures show we're taking more, shorter breaks rather than blowing the lot in one go. Maybe this explains why we have trouble making sure we've taken it all. There's some evidence that taking more short breaks is more re-creational (though I like to make sure of it by taking short breaks through the year and a big break at the end of it). Tourism Australia says there are so many great experiences to be had we should "take the opportunity to visit some more of Australia and gain some lasting memories as well as some great stories to share with others".

It may be advertising copy, but it does have evidence behind it. Psychologists have shown that one reason we get more satisfaction from buying experiences rather than things is the memories and stories we're left with.

Recent research also shows that much of the pleasure we gain from holidays is in thinking about them before we take them. But please don't think that's what I've been doing in this column. And if you're working through, please don't think I'm trying to make you guilty or envious. But I'm off.

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Beware gurus selling high migration

The economic case for rapid population growth though immigration is surprisingly weak, but a lot of economists are keen to give you the opposite impression. Fortunately, the Productivity Commission can't bring itself to join in the happy sales job.

I suspect that, since almost all economists are great believers in economic growth as the path to ever higher material living standards, they have a tendency to throw in population growth for good measure. There's no doubt a bigger population leads to a bigger economy; the question is whether it leads to higher real income per person, thereby raising average living standards.

Of course, business people can gain from selling to a bigger market, regardless of whether the punters are better off. So I'd be wary of advice coming from economists employed by business or providing consulting services to business.

In 2006 the Productivity Commission conducted a modelling exercise to assess the effect of a 50 per cent increase in our skilled immigrant intake. It found that, after 20 years, real gross domestic product was only about 4 per cent higher than otherwise.

And the increase in real income per person was minor. What's more, most of the gains accrued to the migrants themselves, with the existing population suffering a tiny net decline in income. Why this lack of benefit? You'd expect the extra skilled labour to raise the proportion of the population participating in the labour force, thus boosting production per person.

But most of the productiveness of workers are achieved by the physical capital they're given to work with. So unless your extra workers are given extra capital equipment - a process known as "capital widening" - their productivity is likely to decline, thus offsetting the gain from having more workers.

Note, too, that we have to increase the housing stock to accommodate the migrant workers and their families, as well as providing the extra public infrastructure for a bigger population. So the migrants are paid to supply their labour, but the rest of us have to provide the extra economic and social capital they need if standards aren't to fall.

Last week Tony Burke, the federal minister responsible for developing a "sustainable population strategy" next year, released an issues paper to encourage discussion. It was accompanied by the reports of three advisory panels, including one on the economic aspects, led by Heather Ridout of the Australian Industry Group.

Ridout's report sets out to talk up the economic case for high migration by dispelling "myths" and pointing to hard-to-quantify benefits "often ignored by low-growth advocates when they skim the literature" (that's what they call a professorial put-down).

The main hard-to-quantify benefits left out of the Productivity Commission's modelling are the economies of scale arising from a bigger market. But why after all these years have economists been unable to produce good empirical evidence of something as straightforward as scale economies?

And why wax lyrical about unmeasurable benefits without mentioning unmeasurable costs? In its recent booklet on population and immigration, the commission acknowledges that as well as economies of scale there could be diseconomies.

The Ridout report objects that the commission's modelling measured the benefit of increased immigration only over 20 years. Sorry, but if you have to wait more than 20 years for the payoff you're not talking about a powerful effect.

A relatively new argument in favour of high immigration is that it could foster economic growth by countering to some extent the decline in labour-force participation caused by the ageing of the population. But, since immigrants age too, all this can do is put off the evil hour (not a course of action usually promoted by economists). To continue postponing the crunch you have to keep upping the dose of immigration.

The Productivity Commission is blunt: "changes in migration flows are unlikely to have a significant and lasting effect on the ageing of Australia's population".

The Ridout report argues that a faster-growing, immigration-fuelled economy would require greater levels of investment by businesses and in public infrastructure. This greater capital spending would generally involve investment in more productive capital equipment, as recent technological improvements will be embedded in the newer stock. In this way, faster growth of the size of the economy would drive the productivity gains that are central to advances in material living standards, we're told.

Huh? The proposition is that by taking on a need for considerable investment in capital widening (to provide the extra workers with the equipment and infrastructure they need to be as productive as the existing workers) we're increasing the scope for capital deepening (giving each worker more and better capital equipment).

Am I missing something? This is a twist on a common economists' argument I've never managed to fathom: we need to grow more and do more damage to the natural environment because when we're richer we'll be able to afford to fix the damage we've done to the environment.

The Ridout report asserts that provided population growth is "balanced and managed well", living standards will rise. It needs to be "matched by greater commitments to education and skills development, more and better investments in infrastructure, greater attention to the development of our cities and regions and to our natural environment".

In other words, to give business the extra population it wants but prevent this from worsening all those things, governments at all levels will really need to lift their game as well as spend a lot more. Turn in a perfect performance and high immigration won't be a problem.

I prefer the commission's way of putting it: "population growth and immigration can magnify existing policy problems and amplify pressures on 'unpriced' entities, such as the environment, and urban and social amenity".

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A reality check at last on what we take for granted

A recurring theme in my writing this year has been to point out the limitations of gross domestic product as a measure of wellbeing, particularly as related to the environment. But today I have good news: something is being done about it. Economists and statisticians long ago developed a "system of national accounts" to measure developments in the economy, based on Keynesian theory about how economies work.

Although these accounts give much detail about income, production, spending and saving during a period and, these days, a balance sheet outlining the values of the nation's assets and liabilities to the rest of the world on the last day of the period, we tend to focus on a single bottom line: the change in the real value of goods and services produced during the period, otherwise known as GDP.

A United Nations commission sets down an international standard for all countries to follow in preparing their national accounts, using the same theory, concepts and definitions so each country's figures are comparable and can be added together to give gross world product. But as we've become more aware of the problems economic activity is creating for the natural environment - degradation of rivers and soil, depletion of non-renewable resources, use of renewable resources faster than their ability to renew themselves, destruction of species and generation of waste and pollution, including greenhouse gases - we've realised that little of this cost is taken into account in measuring the change in our income.

It's as though we've been thinking of and measuring "the economy" - the production and consumption of goods and services - in total isolation from the natural environment in which the economic activity occurs.

The environment provides the economy with many "ecosystem services", which a leading ecological economist, Professor Robert Constanza, of Portland State University, defines as "the benefits provided to humans through the transformations of resources (or environmental assets, including land, water, vegetation and atmosphere) into a flow of essential goods and services,

for example clean air, water and food".

These ecosystem services are treated as though they're "free goods" - goods in such abundant supply they have no value or cost - while, as we've seen, most of the damage economic activity does to the ecosystem is also ignored.

The main reason for these limitations is that, with some exceptions, the national accounts and GDP don't actually measure "the economy" but rather market transactions within the economy. So, for instance, it ignores all the production and consumption that occurs within households without money changing hands. It measures professional sport, but not amateur sport.

It's clear we can't go on effectively ignoring the relationship between the economy and the environment. The damage economic activity does to the environment diminishes our wellbeing, as well as rebounding on the economy and damaging it. We can go on ignoring the damage excessive irrigation is doing to the Murray-Darling so as to avoid disrupting the livelihoods of the irrigators, but if we eventually turn the river into a drain, irrigation will be no more.

We need to recognise and measure the interrelationship between the economy and the environment because we don't want to give ourselves a false impression of the progress we're making, even in a narrow, material sense. Measurement is important because "what we measure affects what we do; and if our measurements are flawed, decisions may be distorted".

To this end the UN commission and its member national statistical agencies have agreed on a "system of integrated environmental and economic accounting", which will become an international standard in 2012. This brings environmental and economic information together within a common framework, meaning information from each side is on a comparable basis and can thus be combined.

Well that's great. But our longstanding focus on purely economic measurement means we don't yet collect all the data we would need to produce environmental accounts that could be integrated with the economic accounts to give us a more balanced picture of the progress we're making (although, of course, this says nothing about other dimensions of progress, such as the quality of our health, extent of our education, inequality in the distribution of income and treatment of minorities).

It turns out the efforts of our Bureau of Statistics have been concentrated heavily on collecting the reams of statistical information needed to produce the quarterly national accounts.

So that's the first stumbling block. The second is that, with the environment, you have to start with physical measures (millilitres, petajoules, hectares or tonnes) then see if you can convert them to dollar values - as they must be if they're to be combined with the economic accounts. (That's the problem with non-market activities, of course. When something is bought or sold, you know its dollar value.)

The bureau of stats has issued a paper describing its progress in moving Towards an Integrated Environmental-Economic Account for Australia. It needs to produce six accounts that will add up to the environmental side.

A water account (released a few weeks ago and now to be produced annually) includes the physical flows of water supplied to, and used by, the economy, and water returns to the environment. It includes monetary supply and use tables and indicators of the water productivity of industries.

An energy account (to be produced annually from mid next year) includes physical and monetary supply and use tables for various energy products, by industry. A land account (to be produced annually from early next year) includes physical and monetary land use by industry, land cover by industry and changes in land cover over time.

An "environmental protection expenditure" account (to be produced annually from late 2012) gathers together protective spending already included in GDP for things such as waste water treatment. A waste account (to be produced three-yearly from late 2012) covers physical generation and disposal of waste by industry, type of waste and destination.

It would be nice if, having done all this measurement, we could produce from the integrated environmental-economic accounts a single, bottom-line figure for "green GDP", that we could watch as closely as we watch the present brown GDP. As yet, however, the world's statistical agencies haven't agreed on a definition of green GDP, nor agreed on how to convert all physical quantities into dollar values. But there will be enough information to allow outfits or academics to calculate their own versions of green GDP using their own assumptions. And it should be possible to produce a figure for GDP after adjustment for environmental depletion and degradation.

That will be a big step forward.

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Only part of our fortune is down to minerals

If it exercises my doctor's mind I imagine it occurs to a lot of people: are we a stuffed nation living off our mineral wealth? The thought that we're making a lot of our income merely by digging stuff out of the ground and shipping it overseas seems to worry a lot of people. Is that the best we can do?

Considering the fuss politicians, economists and the media are making about the resources boom, you could be forgiven for thinking mining had taken over the economy, but it isn't true. A lot of people think a nation makes its living by selling stuff to the rest of the world. That isn't true, either. Roughly 80 per cent of all the goods and services Australians produce (gross domestic product) is sold to Australians, not foreigners. Similarly, roughly 80 per cent of the goods and services Australians buy is bought from Australians.

In other words, our economy is roughly 80 per cent self-sufficient. At a pinch, we could make it completely self-sufficient, though this would involve a significant decline in our standard of living. Why? Because we'd be denying ourselves access to all those goods and services that other countries produce better or more cheaply than we could.

Here you see the only reason we need to sell things to the rest of the world: so we can afford to import things from the rest of the world. All of us enjoy those imports, but the notion that 80 per cent of us survive by living off the 20 per cent who produce exports is quite mistaken.

Economies work by a process of specialisation and exchange. We each specialise in producing something we're good at, sell what we produce for money (usually wages), then use the money to buy the things we need from other producers. Most of this trade occurs within Australia, but extending our trade to people in other countries makes both them and us better off, because we've got stuff they want and they've got stuff we want.

Thanks to the industrialisation of China and India - accounting for almost 40 per cent of the world's population - the rest of the world is prepared to pay record prices for our coal and iron ore. Those prices won't stay at record levels but, because the process of industrialisation takes quite a few decades, they're likely to stay a lot higher than they were for a long time.

Though minerals and energy now account for about 42 per cent of our export earnings, this still leaves 58 per cent coming from other parts of the economy: 18 per cent from agriculture, 17 per cent from manufacturing and 23 per cent from services (particularly tourism and education).

When you get down to it, mining accounts for only 7 per cent of the value of all the goods and services Australians produce. That leaves agriculture accounting for 3 per cent, manufacturing for 12 per cent and the services sector for 78 per cent.

We have a lingering tendency to denigrate the services sector because it doesn't produce anything you can see and touch. But this is silly. As our standard of living has risen over the years, services account for an ever-increasing proportion of the things we buy (there is, after all, a limit to how much we can eat and how many cars and TV sets we need). And, as we've seen, it's not even true that we can't export services.

It turns out that 84 per cent of working Australians are employed in the services sector - similar to other advanced economies. And although some service jobs are menial - chambermaids, cleaners, waiters and shop assistants - most of the clean, safe, highly skilled, well-paid and intellectually satisfying jobs are in the services sector: doctors, lawyers, bankers, architects, engineers, managers, consultants, clergy, accountants, journalists, actors, media personalities, academics, teachers and many more.

Take away mining and we wouldn't be quite as rich as we are, but most of the economy would look much the same as it does. Most of us would still have good, secure, well-paid jobs.

In other words, our economy has a lot more going for it than just the good fortune of sitting on a lot of valuable minerals.

In Australia, as in every country, public discussion focuses on the bits that aren't working as well as we'd like them to. The bits that are working well get taken for granted. It would be a pity if all this left people with the impression things in Australia are substandard. They're not.

The level of educational attainment in Australia is high and ever-rising. Tests show our 15-year-olds' literacy, numeracy and science are well above average for the developed countries. Seven of our universities are ranked in the top 200 in the world.

With the notable exception of Aborigines, Australians' health is good by international standards. Our longevity is among the highest in the world. So despite all our complaints, we have a good health system, delivering better results than the Americans' at a much lower cost.

Our material standard of living is around average for the rich countries, but likely to go higher. Our gap between rich and poor is also about average, but not as bad as the other English-speaking countries.

For the past 20 years we've had a particularly well-managed economy, with low inflation, falling unemployment and a rising standard of living. Our banks have been well-supervised and kept out of trouble. Most other advanced economies have huge levels of public debt, but ours is minor.

It's true our mineral riches won't last forever, so we do have to make sure we invest the proceeds wisely, particularly in education. But even without mining we still have a healthy, prosperous economy.

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