Resources boom has mined a rich seam for everyone

If you haven't said it yourself, I bet you've heard others saying it: ''Resources boom? What resources boom? Whoever's benefiting from it, I'm not. None of it's come my way.''

Is that what you think? Well, don't kid yourself. Whether or not you realise it, you almost certainly have benefited from the boom.

But how have people who don't work in or near the mining industry - and don't live in Western Australia or Queensland - benefited from the miners' good fortune in being paid way higher prices for their coal and iron ore?

Short answer: everyone's benefited because, as Marx observed, in the economy everything's connected to everything else. Or, to put it in economists' lingo, we're all benefiting because of ''the circular flow of income''.

When I spend my income buying something from you, my spending becomes your income. Then, when you spend your income, that becomes the income of someone else and so on, round and round.
How do you know the notes in your wallet didn't start in the hands of a mining company? You don't. Some of them probably did.

The governor of the Reserve Bank, Glenn Stevens, observed in a speech this week that the higher prices the miners are getting have improved our ''terms of trade'' - the prices we receive for our exports relative to the prices we pay for our imports - by about 85 per cent above their 20th century average.

This constitutes an increase in the nation's real income because the same quantity of exports now buys a great quantity of imports. And Mr Stevens estimates the additional income is equal to at least 15 per cent of our annual income (gross domestic product). Although a substantial fraction of that income accrues to foreign investors who own large stakes in many of our resource companies, what's left still represents a very large boost to national income.

Let's trace the extra income going to the mining companies. Some of it would be going to the people employed in the mines, who've had big pay rises in recent years. This wouldn't be a major factor, however, because mining, being so highly capital-intensive, employs less than 2 per cent of the workforce.

Even so, Stevens estimates that, to produce a dollar of income, the mining companies spend about 40¢ on acquiring ''non-labour intermediate inputs'' - goods and services bought from other businesses.

''Apart from the direct physical inputs, there are effects on utilities, transport, [and] business services such as engineering, accounting, legal, exploration and other industries. It is noteworthy that a number of these areas are growing quickly at present,'' Mr Stevens says.

Most of those businesses would be Australian but many would be from other states. Remember, there are no trade or currency barriers between our states, so a lot of trade occurs across state borders.

Once the costs of producing the mining companies' output, and their taxes , are taken into account, the remaining revenue is distributed to shareholders or retained. While a significant proportion of the earnings distributed goes offshore, local shareholders also benefit.

Who are those local shareholders? We are. Most of us are shareholders in the mining industry through our superannuation schemes. We don't get this income directly to spend now - it's in our super. ''Nonetheless, it is genuine income and a genuine increase in wealth,'' Mr Stevens says.

His rough estimate suggests that about 10 per cent of our superannuation assets - $130 billion - is invested in resource companies. And this 10 per cent has been providing a healthy return: over the past year alone, the average return on resources company shares has been about 20 per cent.

A good proportion of the earnings retained by companies is being used to fund the construction of new mines and natural gas facilities. Mr Stevens estimates that about half the demand generated by these projects - for construction and manufacturing - is filled locally.

In contrast to the operation of mines, the construction of them is labour-intensive. Workers are being attracted from all over Australia, which creates job vacancies in the parts of Australia from which they come and also puts upward pressure on the wages paid to people in the relevant occupations - whether or not they make the move. Now let's think about all the taxes the mining companies pay. The federal government's company tax takes 30 per cent off the top of the companies' profits (after granting the companies generous deductions for the depreciation of their assets).

It was booming company tax collections that prompted the Howard government to offer cuts in personal income tax for eight years in a row. So if you've enjoyed any of those tax cuts you can't claim to have had no benefit from the resources boom.

The mining companies also make big royalty payments to their state governments as a price for all the publicly owned resources they pull from the ground. But even if you don't live in WA or Queensland you've still benefited.

How so? The proceeds from the federal government's goods and services tax are divided between the states using a complicated formula that has the effect of spreading the royalty proceeds proportionately between all the states and territories.

Yet another less-than-obvious way the proceeds from the resources boom have been spread around the economy is via the exchange rate. The primary reason our dollar is so high at present is the high prices we're getting for our exports of minerals and energy. And the high dollar has reduced the price of imported goods and services.

So every business that buys imported equipment or components is benefiting from the resources boom, as is every consumer who buys imported stuff - which is all of us. If you've taken an overseas holiday, for instance, you've benefited. If you've taken a local holiday you've probably benefited, too, because foreign competition is holding down local prices.

If you've bought petrol, you've benefited (because the higher dollar has reduced the effect of the rise in the world price of oil).

Now, if you say our non-mining export and import-competing industries have been harmed by the boom-caused rise in the dollar, that's true. In economics, nothing that has benefits comes without costs.

So it's fair enough for those people in the adversely affected industries to argue that, for them, the costs of the resources boom have outweighed the benefits.

But they're a minority. For the great majority of us, the benefits have far outweighed the costs.

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Great cities inspire us to reach for the sky

As I'm sure you've heard, for the first time in human history more than half the world's population lives in cities. In the developing countries, particularly China, the urban population is growing by 5 million a month. In rich and poor countries alike, cities are a magnet. But why are people so keen to crowd into congested, expensive cities?

The explanation has to be primarily economic, but most economists studiously ignore the spacial dimension of economic activity. There is, however, a notable exception: Professor Edward Glaeser, of Harvard University, is one of the world's leading experts on urban economics.

In his new book, Triumph of the City, Glaeser proclaims cities to be humans' greatest invention. Why? Because they make us rich. ''Urban density provides the clearest path from poverty to prosperity,'' he says. People who live in big cities not only earn a lot more than those who don't, they're more productive.

Cities are ''the absence of physical space between people and companies''. This closeness generates ''economies of agglomeration''. Producing a product close to a large market cuts costs by allowing large-scale production and reducing distribution expenses. The bigger the city, the greater the scope for firms to specialise in particular fields. Firms know they'll have less trouble finding the labour they need in a big city; workers come to cities knowing there'll be plenty of good jobs.

Historically, big cities often arose because they were convenient hubs for national or international trade in particular products. Many developed their own manufacturing industries - garment-making in New York, cars in Detroit, for instance. But such areas of strength can be challenged by changes in technology. Big reductions in the cost of transport and communications have brought about ''the death of distance'' and shifted much manufacturing to developing countries where labour is cheaper.

Detroit has never recovered from greater competition with Japanese and other Asian carmakers. Its population is less than half what it was. New York lost most of its manufacturing industry, but began reinventing itself in the 1970s. Today, more than 40 per cent of Manhattan's payroll is the financial services industry.

This experience leads Glaeser to emphasise a different driver of the benefits of cities: knowledge.

''Humans are an intensely social species that excels, like ants or gibbons, in producing things together. Just as ant colonies do things that are far beyond the abilities of isolated insects, cities achieve much more than isolated humans,'' he says.

''Cities enable collaboration, especially the joint production of knowledge that is mankind's most important creation. Ideas flow readily from person to person in the dense corridors of Bangalore or London, and people are willing to put up with high urban prices just to be around talented people, some of whose knowledge will rub off.''

Cities magnify humanity's strengths. Because humans learn so much from other humans, we learn more when there are more people around us. Urban density creates a constant flow of new information that comes from observing others' successes and failures. Cities make it easier to watch, listen and learn.

Pundits have predicted that improvements in information technology will make urban advantages obsolete. Once you can learn from Wikipedia in Gilgandra, why pay Sydney prices?

''But a few decades of high technology can't trump millions of years of evolution,'' Glaeser says. ''Our species learns primarily from the aural, visual and olfactory clues given off by our fellow humans. The internet is a wonderful tool, but it works best when combined with knowledge gained face to face, as the concentrations of internet entrepreneurs in Bangalore and Silicon Valley would attest.''

An experiment challenged groups of six students to play a game in which everyone could earn money by co-operating. One set of groups met for 10 minutes' face-to-face to discuss strategy before playing. Another set had 30 minutes for electronic interaction. The groups that met in person co-operated well and earned more money. The groups that only connected electronically fell apart, as members put their personal gains ahead of the group's needs.

This fits with many other experiments, which have shown that face-to-face contact leads to more trust, generosity and co-operation than any other sort of interaction.

Cities, and the face-to-face interactions they engender, are tools for reducing the ''complex-communication curse''. Long hours spent one-on-one enable listeners to make sure they get it right. It's easy to mistakenly offend someone from a different culture, but a warm smile can smooth conflicts that could otherwise turn into flaming emails.

Glaeser says the ''central paradox of the modern metropolis'' is that proximity has become even more valuable as the cost of connecting across long distances has fallen. His explanation is that the declining cost of connection has only increased the monetary returns to clustering close together. Before, high transport costs limited the ability to make money quickly from selling a good idea worldwide. ''The death of distance may have been hell on the goods producers in Detroit, who lost out to Japanese competitors, but it has been heaven for the idea producers of New York, San Francisco and Los Angeles, who have made billions on innovations in technology, entertainment and finance.''

So what do you have to do to be a successful city? Well, first, you have to overcome the three main costs of cities: disease, crime and congestion. After you've achieved clean water (solved the sewerage problem), the harder goals are safe streets, fast commutes and good schools.

Cities thrive when they have many small firms and skilled citizens. Industrial diversity, entrepreneurship and education lead to innovation. Innovation allows cities to overcome setbacks and stay prosperous.

''Human capital, far more than physical infrastructure, explains which cities succeed,'' Glaeser concludes. ''Infrastructure eventually becomes obsolete, but education perpetuates itself as one smart generation teaches the next.''

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Far too much economic news for our own good

Ian Macfarlane, the former governor of the Reserve Bank, thinks Australians get too much news about the economy, and this surfeit actually worsens the decisions we make about investments.

At the risk of being drummed out of the economic journalists' union, I suspect he's right. But I'll let him do the talking (he was delivering the Mosman Address at Mosman Art Gallery on Friday night).

Over the past couple of decades the public has been inundated with economic statistics, he says. "The newspapers and magazines are full of economic news, television reporting is saturated with it, there are special radio and television programs devoted to it."

It's true this is a worldwide phenomenon, but it's more pronounced in newspaper coverage in Australia. Foreign visitors often express surprise at how much economic coverage there is in Australian papers, particularly on the front page.

A few years ago the Reserve compared the coverage of central bank monetary policy decisions in three countries: the US, Britain and Australia. It looked at three comparable papers in each country, including The Australian Financial Review, The Australian and The Sydney Morning Herald.

Adding up the number of articles in the three days surrounding two successive monthly monetary policy meetings, it found 35 in the US, 46 in Britain and (wait for it) 131 in Australia. Looking just at articles on the front page, there was one each in the US and Britain, but 14 in Australia.

Why is there so much more economic coverage in Australia than elsewhere? Maybe because there's not much other news to report.

"We are not an international power or trouble spot, we are not engaged in major wars, we do not have racial riots, civil insurrections or sectarian violence. And the private lives of our politicians are not as lurid as British ones (or a recent American president). So instead our newspapers are taken up with recent figures on employment, interest rates, the consumer price index or the budget," Macfarlane says.

[There's an alternative explanation, however. In the US and Britain the link between changes in the official interest rate and changes in mortgage interest rates is quite loose, whereas here it's direct and immediate.]

"With the media competing so strongly against each other, there is inevitably a bias towards sensationalism. While Australia has a few experienced and thoughtful economic commentators who are world class, it also has a multitude of eager beavers who are mainly concerned with tomorrow's headlines," Macfarlane says.

"They try to extract the maximum amount of coverage out of each ephemeral piece of news - monthly or even daily figures are invested with a significance well beyond their actual information content."

Interest rates don't merely rise, they "soar", the exchange rate "dives" or "plunges" and budgets "blow out". The reader is left with the impression of constant action and turmoil. The recurring television image is of people in dealing rooms or on the floors of futures exchanges shouting at each other.

Another feature, he says, is the tendency to concentrate on pessimistic news. It's the nature of all journalism - not just economic - that its practitioners seek to expose a disaster or a conspiracy.

No one ever wins a prize in journalism by pointing out that things are proceeding relatively smoothly and uneventfully, hence the tendency to find bad news and mistakes in policy, and to label every minor glitch as a crisis (the most overworked word in journalism).

"At the margin I believe all this news tends to make us less confident, less secure and less happy than if we had less of it," he says.

But does all this information make us better at doing our jobs or investing our savings? Macfarlane says a broad range of information is better than a narrower one, but more frequent information about a particular thing may stop us seeing the wood for the trees.

More frequent information also exposes us to the "narrative fallacy" - our need to tell a story about why a movement in an economic variable occurred, even if it's just a small daily movement in the exchange rate or the sharemarket. Often the movement is just random noise, but we can't say that.

Macfarlane says several financial advisers have told him that, among their clients, those who spend the most time tracking daily movements in their portfolio do worse on average than those who review their portfolios less frequently.

Research has shown that most people exhibit "loss aversion" - they experience more unhappiness from losing $100 than they gain in happiness from acquiring $100.

So the more often they're made aware of a loss the more unhappy they become.

If the sharemarket rises by 6 per cent a year that, plus dividends, is a reasonable return. But on average the market would fall on about 47 per cent of days and rise on 53 per cent. This suggests a net fall in happiness despite the satisfactory return. Reviewing the market monthly rather than daily would produce a smaller proportion of losses, making us happier.

Behavioural finance research shows that, because we suffer from myopia as well as loss aversion, investors who get the most frequent feedback take the least risk and thus earn the least money.

In listing the false signals given by the rule that two successive quarters of falling real gross domestic product constitute a "technical" recession last Monday, I missed one. No one knew it at the time, but the Bureau of Statistics' latest estimates show the economy contracting by 0.02 per cent in the September quarter of 2000 and then by 0.4 per cent in the December quarter. So, a recession on John Howard and Peter Costello's watch? No, just a stupid rule.

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Quest to make uni fees a heck of a lot fairer

One measure in the May budget's tightening up on ''middle-class welfare'' drew surprisingly little debate: the decision to cut the rate of discount offered to people who pay off their university HECS debt up front from 20 per cent to 10 per cent.

When the higher education contribution scheme was introduced in the late 1980s, the discount for paying up front was 25 per cent. Now it's falling to 10 per cent. And the discount for making voluntary repayments of $500 or more is to be cut from 10 per cent to 5 per cent.

Wayne Swan says the move will save the government almost $300 million over four years and will make the scheme fairer.

But why would it save that much? And how would it make things fairer? That the shock jocks didn't bother debating these questions probably means people bright enough to go to uni don't ring up talkback radio.

It is a bit of a puzzle. The first question is, why would the government give any discount to people paying their HECS up front rather than paying it off over the years as their income rises and the taxman extracts it from their pay packet?

Well, the government's better off getting the money up front rather than having to wait maybe 10 or 15 years for it all. So it makes sense for the government to give people an incentive to pay up front.

But, if that's the case, why does it make sense to reduce the incentive? Surely the rational response to a reduced incentive for early payment would be for fewer people to pay up front. And if that's the case, wouldn't that leave the government's coffers worse off rather than better off?

Well, it seems the econocrats are expecting some of those who'd otherwise pay up front to be put off, but not many. But see what this means? They're not expecting a rational response to the move.

This is one case where the econocrats aren't proceeding under the assumption we're all like Homo economicus - economic man - carefully calculating and self-interested in all we do.

And I've no doubt they're right: there won't be a rational response to the cut in the discount. Why not? Because paying HECS up front has never been a rational thing to do. It follows that the response to the cut in the discount isn't likely to be rational, either.

Perhaps we should start from the beginning. The wider community benefits when young people go to university and get a degree. But the greatest benefit goes to the graduate. On average, possession of a degree causes workers to earn a lot more over their working lives.

So HECS was introduced to require graduates to make a greater - though still far from full - contribution towards the cost of their education, reducing the subsidy they receive from other, less fortunate taxpayers.

You can think of higher education as an investment. You make an initial outlay (the main cost being not for fees or books, but the income forgone while you study rather than work) in return for lifetime earnings that are higher than they would have been.

According to one study in 2002 by Professor Jeff Borland, of the University of Melbourne, uni graduates earn an average of almost $10,000 a year more than high school graduates do. After allowing for the initial outlay, this was equivalent to an investment return of about 20 per cent a year.

That was without including HECS. Allowing for HECS (which was then at a lower rate than it is today), cut the annual return to about 14 per cent - still a very good deal.

But wouldn't charging fees discourage bright young kids from poor families from going to uni and bettering themselves? That was the risk. But HECS was carefully designed (by Professor Bruce Chapman, of the Australian National University) to avoid this happening.

Rather than simply levying tuition fees, the government would allow people to defer payment of the fees until they'd graduated and were earning a reasonable salary. Then they'd have to pay a small proportion of their salary in repayments, with the proportion rising as their salary grew.

So the government was, in effect, lending students the cost of their uni fees. It didn't charge interest on the loan, but did index the value of the balance outstanding to the inflation rate. In other words, it changed people a real interest rate of zero.

By contrast, any loan you get during your life from a bank or finance company will involve a high real interest rate and a fixed repayment schedule that takes no account of how hard or easy it is to meet the payments (it's not ''income-contingent'' like HECS is).

See what this means? HECS is the best loan - the cheapest money - you're ever likely to get. So the rational response is not to pay it off any earlier than you have to, thereby avoid having to borrow as much commercially for other purposes or being able to keep more money in the bank earning interest.

This is true even with a discount - 25 per cent, let alone 10 per cent - for repaying the loan up front.

(You can check this by working out the ''present value'' of the debt by discounting the flow of repayments over the life of the loan, so as to take account of ''the time value of money''. Don't know what all that means or how to do it? Go to uni and do an economics or business degree and they'll tell you.)

But if it makes no sense to do the government a favour and repay HECS debts up front, why do people do it?

I doubt if many students do it. It's much more likely to be well-off parents who do it (one of whom is very well known to my good self) so their little darlings don't have to worry about being in debt.

If this is the motive of those people who pay HECS up front, they're unlikely to be

deterred by a cut in the rate of discount.

Thus the government probably will make significant savings.

And since those savings will come from the pockets of well-off parents, it's probably right to see this measure as an attack on middle-class welfare that will make the scheme fairer.

A last point: in the real world, a lot of the things we don't do aren't strictly ''rational'' - but all that does is make us human.

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Sympathy for those on $150,000, but...

One thing I despise about public life in Australia today is the way power-chasing pollies and self-promoting media personalities seek to advance themselves by encouraging people living during the most prosperous period in our history to feel sorry for themselves. Apparently, the soaring cost of living is absolutely killing us.

So forgive me but, just this once, we're going to worry about other people's problems, not yours.

Years ago, long before I became a journalist, I used to do the tax return of a lecturer in social work. One day he dumbfounded me by remarking that it wasn't good enough to measure poverty in money terms.

I was just a simple accountant; what on earth was he on about? How else could you judge it?

It's taken me a long time to realise he was on to something. Part of the trouble with economics is its confident assumption that all problems worth worrying about can be measured in dollars.

The economist Professor Peter Saunders, of the University of NSW, is probably Australia's leading expert on poverty. But in his latest book, Down and Out, he argues that poverty - lack of income - is just one aspect of the broader problem of social disadvantage. The other aspects are deprivation and social exclusion.

''Social disadvantage'' refers to a range of difficulties that block life opportunities and prevent people from participating fully in society. Although poverty is a factor contributing to disadvantage, the root causes of disadvantage extend beyond the lack of money and need to be identified and tackled separately.

Saunders offers the example of Leah, a single parent born in North Africa, now living in the south of Israel, leading a harsh and miserable life dominated by men.

Giving Leah money could help her a lot, but unless something is done about the underlying causes of her problems - lack of education, exposure to discrimination, lack of voice in events that affect her, induced depression, unwise choices and bad luck - there will be little prospect of relieving the disadvantages she experiences and preventing them from being transmitted to future generations.

Do you really think there are no Leahs in Australia?

''Cycles of poverty that result from an inadequate education that restricts employment prospects and constrains earnings will not be prevented by income transfers alone, but also require efforts to raise human capital in ways that can provide the foundation for economic independence and improved social status,'' Saunders says.

One of the most important determinants of social disadvantage is where you live. This is true not only of which country you live in, but also of where you live within a country. ''Increasingly, where one lives can have a powerful impact on access to employment, on the ability of a given level of income to support a particular standard of living and on the availability and effectiveness of services to address disadvantage,'' he says.

Tony Vinson, a former professor of social work, has written that ''when social disadvantage becomes entrenched within a limited number of localities, the restorative potential of standard services in spheres like education and health can diminish.

A disabling social climate can develop that is more than the sum of individual and household disadvantages and the prospect is increased of disadvantage being passed from one generation to the next.''

Historically, poverty has been measured by setting a level of income and saying everyone who falls below that line is poor. But such ''poverty lines'' can be set in fairly arbitrary ways - half of the median income is a common measure, for instance - and so are open to argument.

The concept of ''deprivation'' has been developed to try to measure poverty more directly. It seeks to identify what is an unacceptable standard of living by using community views to specify the items and activities that are regarded as normal or customary in a particular society at a particular time.

Surveys show that the list of items Australians regard as the ''essentials of life'' include such things as medical treatment if needed, warm clothes and bedding if it's cold, a substantial meal at least once a day, and the ability to buy medicines prescribed by a doctor. By contrast, the concept of ''social exclusion'' focuses on how relationships, institutions, patterns of behaviour and other factors (including lack of resources) prevent people from participating fully in the life of their community.

Australian research has divided social exclusion into three domains: disengagement, service exclusion and economic exclusion. Indicators of disengagement include: no regular social contact with other people, children don't participate in school outings, children have no hobby or leisure activity, and unable to attend wedding or funeral in the past 12 months.

Indicators of service exclusion include: no access to a local doctor or hospital, no access to dental treatment, no childcare for working parents, no aged care for frail older people, and no access to a bank or building society. Indicators of economic exclusion include: not having $500 in savings for use in an emergency, having to pawn or sell something in the past 12 months, not having spent $100 on a special treat in the past 12 months, and living in a jobless household.

The groups with the highest risk of facing ''deep exclusion'' are (in declining order) unemployed people, public renters, lone parents, indigenous Australians and private renters.

So that's how the other half lives. What a pity these people have no idea what a struggle it is trying to make ends meet on $150,000 a year.

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This time it's a recession we don't have to have

Though nothing is certain in the unpredictable world of the national accounts, it's highly unlikely we'll see a second, successive quarter of ''negative growth'' when the figures for this quarter are released in early September. Which, in a way, will be a pity.

Why? Because even if the hiccup caused by our natural disasters had spread itself over two quarters - after the 1.2 per cent contraction in the March quarter - not even the most ignorant journalist or most excitable market trader would have believed the consequent ''technical recession'' was a real recession.

The reason the rule about two successive quarters of falling real gross domestic product amounting to a ''technical'' recession (whatever that is) won't lie down and die is its handiness: it's simple to judge, objective and involves minimum waiting.

The reason it should bite the dust is that it's a completely arbitrary rule of thumb containing no science, which is perfectly capable of telling us we're in recession when we're not, or failing to tell us we're in recession when we are.

It's also unreliable in another sense because it's based on the Bureau of Statistics' first estimate of the quarterly change in GDP, which is subject to heavy revision in subsequent months and years. (Keep reading.)

It was because all the contraction after the global financial crisis was crammed into a single quarter (the fall of 0.9 per cent in the December quarter of 2008) that the Rudd government got away with the claim that we avoided recession even though, in truth, we had a mild recession involving a rise in unemployment of almost 2 percentage points.

Kevin Rudd, Ken Henry & Co timed their stimulus packages with the clear (if unacknowledged) objective of ensuring there weren't two quarters of contraction in a row. They did this in the belief that, whatever the realities of the situation, the fuss the media would make about ''technical recession'' would be certain to further damage business and consumer confidence and make the talk of recession self-fulfilling and the downturn deeper.

They were right and they deserve a medal. They understood - as few macro-economists do - the central role the management of our animal spirits plays in determining the severity of downturns.

They also understood that the effectiveness of cash splashes and other give-aways is determined as much by their effect on how people feel about the future as by the size of the increase in spending they immediately bring about.

Once the second successive quarter had been avoided, the government happily trumpeted the (false) news that we'd avoided recession - no doubt believing it was merely reinforcing the more confident outlook.

But no good deed goes unpunished. The opposition was happy to accept the no-recession line but, in a novel twist on the post-hoc-ergo-propter-hoc fallacy, turned it back on the government, arguing that all the money Labor spent trying to moderate a recession was obviously wasted. (The fallacy says, since A preceded B, therefore A caused B. The opposition's version was, since there was no recession, therefore there was no need for all the spending to stop it happening.)

Not many people remember it was the old two successive quarters rule that lured Paul Keating into making his hugely resented remark about the recession we had to have. Though, in 1990, Keating and Treasury had been assuring us we were in for no worse than a ''soft landing'', by the time the national accounts for the June quarter showed a contraction of 0.9 per cent, most people needed no convincing we were in deep trouble.

Even so, Keating persisted with his denial. But by late November, on receiving the September quarter accounts showing a whopping contraction of 1.6 per cent, he realised the game was up and (to his eternal regret) decided to brazen it out, preferring to be seen as a conniving knave rather than the miscalculating fool he really was.

At his news conference to respond to the accounts, his opening words were: ''The first thing to say is, the accounts do show that Australia is in a recession. The most important thing about that is that this is a recession that Australia had to have.''

But here's the joke. Remember what I said about initial estimates being subject to heavy revision? By now, the first of his successive contractions has been revised from minus 0.9 per cent to plus 0.4 per cent. The second has been revised from minus 1.6 per cent to minus 0.4 per cent.

So applying the two-quarter rule to the bureau's by-now reasonably accurate estimates, Keating confessed to a recession that didn't exist. Except, of course, that at the time everyone knew from the evidence that it did - and they were right.

Since, according to the latest estimates, the economy grew in the following, December quarter, it wasn't until early September the next year - nine months later - that the two-quarter rule was signalling the arrival of recession.

A rule of thumb that throws up so many false negatives - in 1990-91 and 2008-09 - is a rule that should be ditched. The economist Saul Eslake has road-tested a different rule, showing it has produced no false signals. It defines recession as ''any period during which the rate of unemployment rises by more than 1.5 percentage points in 12 months or less''.

But I prefer the definition offered by David Gruen, of Treasury: ''A sustained period of either weak growth or falling real GDP, accompanied by a significant rise in the unemployment rate''.

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GDP hot air gives Hockey hiccups

See how long it takes you to figure this one out: if something falls by 50 per cent, then rises by 100 per cent, where is it? Answer: just back where it started.

If you had to think about it you need to be careful what conclusions you draw from this week's national accounts showing the economy - real gross domestic product - contracted by 1.2 per cent in the March quarter.

Thanks to economists' obsession with growth, we focus almost exclusively on the percentage change in GDP and its components from one quarter to the next, but if you don't have a good feel for how percentage changes work you risk bamboozling yourself.

(Speaking of which, remember that, though the percentage increase needed to get you back to par is always bigger than the original fall, the smaller that fall the less spectacular the subsequent rebound.)

Now try this reaction to the national accounts from Joe Hockey: ''If the mining boom has a cough the Australian economy can suffer pneumonia. The economy is increasingly reliant on the mining boom.''

It's a snappy soundbite for the telly, but it's nonsense. Indeed, it's roughly the opposite of what the national accounts are telling us.

For a start, the problem during the March quarter wasn't the mining boom, it was the weather. Is our economy heavily reliant on the weather? Our farmers are, but the rest of the economy isn't (well, not until we're finally screwed by climate change).

For another thing, what happened last quarter wasn't a cough that shows we've got pneumonia, it was a hiccup that isn't worth worrying about. Remember, 98.8 per cent of the economy was still there in the March quarter.

All that happened was that flooding and cyclones temporarily disrupted our production of coal, iron ore, agriculture and tourism. The disruption to mining in particular led to a decline of 27 per cent in the volume of coal exports during the quarter, causing the volume of all exports to fall by 8.7 per cent.

But today, two months after the end of the March quarter, we know the bad weather has stopped, most mines are working again, farmers have replanted and the rebuilding of houses, roads and other infrastructure has begun. Export volumes recovered in the month of March and further in April.

The natural disasters are estimated to have subtracted 1.7 percentage points from real GDP growth during the quarter. But Wayne Swan is expecting a rebound of about 1 percentage point in the present quarter and a further rebound in the September quarter. This is why Hockey's pneumonia is no more than a hiccup.

The rebound will come for three reasons: production will return to normal; some firms will work overtime to catch up on lost production and there will be much rebuilding and purchasing of new equipment.

Note that, thanks to our obsession with rates of quarterly change, part of the rebound is simply arithmetic. The government estimates the various natural disasters subtracted $6.2 billion from the real value of production in the March quarter, but will subtract only $3.1 billion in the June quarter. If so, this reduction in a negative represents a positive contribution to the growth in real GDP in the June quarter.

The point is, when the economy contracts in a quarter, you have to investigate the causes before you decide the economy has pneumonia and needs to be hospitalised. In this case, the causes are transitory - and self-correcting - rather than lasting.

Another clue is that the economy suffered a weather-caused shock to its supply side (production of goods and services) rather than weakness in its demand side (spending on goods and services).

A weakness in demand is more likely to be deeper-seated and longer-lasting, requiring the economy's demand managers - the government and the Reserve Bank - to adjust the settings of the instruments they use to influence the strength of demand: respectively, fiscal policy (the budget) and monetary policy (interest rates).

What makes Hockey's talk of pneumonia so opposite to the truth is, when you look past the temporary supply problem you see demand growth is quite healthy. Consumer spending grew by 0.6 per cent in the March quarter (and by 3.4 per cent over the year to March), with government spending on consumption items growing by 1.4 per cent (4.6 per cent for the year).

Turning to investment spending, spending on new or altered housing grew by 4.6 per cent (annual, 6.6 per cent) and business investment in new equipment and structures grew by 2.9 per cent (annual, 4.5 per cent).

That leaves public sector investment spending, which fell by 0.7 per cent (annual, minus 6 per cent) as the fiscal stimulus continued to be withdrawn. (Overall, the withdrawal of stimulus trimmed 0.4 percentage points from GDP growth during the quarter.)

Adding this up, ''domestic final demand'' grew by a whopping 1.3 per cent during the quarter and by 3.3 per cent over the year. Allowing for a fall in the level of business inventories (much of it probably caused by the natural disasters), ''gross national expenditure'' - which is domestic demand proper - grew by a healthy 0.8 per cent during the quarter and by 3.1 per cent over the year.

This healthy growth ain't surprising since total employment grew by almost 50,000 during the quarter.

As the secretary to the Treasury, Martin Parkinson, pointed out this week, though the mining sector gets most of the headlines, it accounts for only about 8 per cent of GDP (and an even smaller proportion of total employment). So that leaves 92 per cent of the economy that's not mining but is doing fine.

It's true that, of late, much of the growth in the economy has been coming, directly and indirectly, from mining. But it's rare for all parts of the economy to be growing at the same rate, so it's common for one sector - often it's been housing - to account for much of the growth in a particular period. That doesn't mean we'd catch pneumonia were that sector to falter.

Consider this: if the sky-high prices we're getting for coal and iron ore were to suddenly collapse, that would be a blow, but it would also bring about changes that encouraged other sectors to grow faster: the high exchange rate would fall, the Reserve Bank would cut interest rates and the budget wouldn't be as contractionary, taking longer to return to surplus.

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Mouse is mightier than the stores

Well-mannered newspapers don't spend a lot of time talking about themselves. Even so, you've no doubt heard that the future of newspapers - though not news or journalism - is under great challenge from the arrival of the internet.

Much classified advertising has moved to the net and now some display advertising is going.

Some readers are moving to the net, smartphones and tablets such as the iPad.

As you may imagine, these are anxious times for newspaper managers and print journalists.

It's dawned on me, however, that what the internet is doing to the media is just for openers.

You wait until you see what it does to retailing over the next decade or two.

Retailers have been complaining lately about people buying more stuff on the internet - and thus being able to avoid paying goods and services tax on purchases of less than $1000 - but I doubt if this does much to explain their present weak sales.

A report by Southern Cross Equities shows that by last year local online retailers had a 4 per cent share of total retail sales.

This was up from 2 per cent in 2005, but it's still not a lot.

Yet come back in 10 years and it may be a very different story.

Buying things in shops has many advantages. You're able to see, touch and even try on what there is to choose from. You can seek further information from a live human. There's less worry about the security of your payment and being able to return goods that prove unsatisfactory.

So why would people buy online? Partly because, if you know what you want, it's very convenient. You avoid having to find a park at crowded shopping malls and avoid unwanted human contact.

But a new study by Ben Irvine and colleagues at the Australia Institute, The Rise and Rise of Online Retail, finds that online shoppers give ''saving money'' as their primary reason. ''Bargain hunters'' outnumber ''mall haters'' five to one.

When bricks-and-mortar retailers also run a website they tend to charge the same prices on both. If they didn't, more of their customers would switch to online. Add the cost of postage (and ignore the cost in time and money of travelling to their shop) and it's often not particularly attractive to buy from local retailers online unless you find one offering a much lower price.

It's when people browsing prices on the internet compare prices being offered on overseas sites that they find large savings, sometimes up to 50 per cent - savings that make the freight costs well worth paying. This is true for books, DVDs, music, shoes, electronic goods and much else.

People are amazed to find that global corporations are selling the identical goods at quite different prices in different countries.

As a very broad generalisation, prices tend to be low in the United States and high in Australia, with British prices somewhere in between.

Our retailers and others try to justify these differences by reference to freight costs, differences in taxes, the high Aussie dollar and much else, but they never can.

Many people imagine prices are based on the cost of manufacture and distribution, plus a reasonable mark-up. But, in economists' speak, this is just looking at the supply curve.

You also have to take account of the demand curve, which shows the prices customers are
''willing to pay''.

Taking this into account means prices are set at the highest level ''the market will bear''. Charging different prices in different markets (whether those markets are in different countries or are different segments of the same country's market) is a long-standing business strategy.

You maximise your profit by charging whatever price - high or low - is the most the people in each market or market segment are willing to pay.

Economists call this ''price discrimination'' and regard it as perfectly reasonable.

Now here's something the economists won't tell you: people are willing to pay higher prices in Australia because that's what they're used to. People are willing only to pay lower prices in the US because that's what they're used to.

As every economics textbook will tell you, however, the trick to successful price discrimination is you have to be able to keep the markets separate, otherwise people in high-price markets will switch to buying in lower-price markets.

Guess what? The internet has broken down the geographic (and knowledge) separation between national markets. So the game is up for country-based price discrimination. It will take a while but, as e-commerce spreads, our greater ability and willingness to buy from countries with lower prices will force Australian retail prices down, particularly website prices. (The day may come when people who want personal service in a shop will have to pay a premium above the internet price.)

This will be an enormously painful process for retailers and their employees (welcome to the club). And also for the firms that own and rent out retail space.

It will be painful because it's wrong to imagine Australian retailers charging twice as much for the identical product as US retailers charge are therefore making twice the profit.

Why not? Because, over the many decades this price difference has existed, Australian retailers' cost structures have adjusted to fit (just as broadsheet newspapers' staffing levels increased to absorb most of the ''rivers of gold'' flowing from their classified ads). In particular, the rent paid by retailers would be much higher.

The internet is changing the world to make it work more like economics textbooks have always assumed it worked.

It's intensifying price competition over other forms of competition, such as marketing, and slowly bringing to reality a concept beloved of economists: ''the law of one [worldwide] price''.

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Coles and Woolies loom as Big Tobacco's rivals

What do the big foreign-owned mining companies have in common with the big foreign-owned purveyors of cancer sticks? A lot of money to con punters and pressure pollies, and a lot of weak arguments.

One argument the two industries have in common is that the resource super-profits tax and the plain packaging of cigarettes lack any proof they will work and have never been adopted anywhere in the world. Great argument: it has not been done before, therefore you shouldn't do it.

This is the poor little stupid Australia argument. We should always merely follow the lead of other countries because we're not smart enough to dream up anything good ourselves. Its logic is foolproof: if it has never been done before there's no evidence it works, and if we never try it there never will be.

But if the idea's so unlikely to work, why are the global giants fighting so hard to stop it being tried? Why not leave the stupid Aussies to stew in their own juice? Perhaps because the rest of the world is watching our ''experimental legislation'' and if it works - as it's most likely to - other, bigger countries will copy it.

The big miners claimed the supposedly retrospective introduction of the super-profits tax would increase Australia's ''sovereign risk''. The big tobacco-pushers claim plain packaging would rob them of their brands and infringe ''international trademark and intellectual property laws''.

They've claimed they'll contest the issue to the fullest extent of the law - this I do believe - and are crying bitter tears over the ''billions of dollars'' this will cost taxpayers in legal fees and compensation to the injured companies.

From what the experts say, however, the companies' legal case seems weak. About the only people convinced they'll succeed in this are from the libertarian Institute of Public Affairs. (If the institute isn't receiving tax-deductible donations from the tobacco industry, I'll be happy to record its denial.)

Libertarians are tireless fighters for private property. They're willing to pay taxes pretty much only to the extent they're necessary to finance government actions to protect private property from being stolen or overrun by foreign invaders.

But I find it curious the institute is so ready to extend its attitude towards the protection of physical property to the protection of intellectual property such as patents, copyright and trademarks. Protection of intellectual property involves much more overt intervention in the market. It's the nanny state creating monopolies and conferring them on private firms.

This intervention can be justified only by acknowledging the existence of market failure (something libertarians are usually most reluctant to do) and then being satisfied the intervention won't make matters worse.

You're actually giving some firms a licence to charge higher prices (by constraining their competitors from copying them) and recent history is full of instances of industries successfully lobbying the nanny state to extend intellectual property rights in ways that benefit the rights-holders at the expense of the public interest.

Yet another argument put up by tobacco companies is that plain packaging will backfire and lead to increased smoking because taking away the companies' distinctive branding (though not their brand names) will lead to greater price competition. Lower prices would lead to higher consumption, which would defeat the object of the exercise and actually increase smoking rates among young people. (Just why this would be a bad thing the companies don't explain. Cigarettes aren't bad for you, are they?)

I suppose when you're fighting to defeat some government measure it's always handy to have some argument it would be counterproductive, but this is a strange argument for them to be running. If there were an outbreak of price competition in response to plain packaging, the government could fix the problem easily by increasing its tobacco excise and forcing the retail price back up to where it was. This would be a nice outcome. The extra tax revenue would, in effect, be coming from the companies, leaving smokers no more out of pocket than before the new arrangement.

Though in these circumstances industries on the make usually lay it on pretty thick, the companies have made no attempt to claim the price war would send them broke, oblige them to lay off thousands of workers or move to China. This is a tacit admission that their degree of profitability - on their own admission, fattened by the ability branding gives them to charge higher prices - is so great it would survive a price war.

After examining the companies' rates of return relative to competitive norms, Dr Richard Denniss, executive director of the Australia Institute, estimates about half their profits - $500 million a year - flows from the premium prices charged for ''branded'' tobacco.

The companies say they fear the increased price competition would come from illegally imported tobacco, with smuggling ''spiralling out of control''. But Denniss thinks it's more likely to be the reactions of the big two supermarket chains the companies are worried about.

At present, the ban on tobacco advertising effectively protects the established players from having to compete with new entrants to the market. Apart from starting a price war, advertising would be the only way you could draw smokers' attention to your arrival in the market. (This is advertising doing what it suits economists to assume it always does: not using allusions and illusions to entice people to buy, but merely informing potential purchasers of your availability and price.)

But when plain packaging robs the established players of their last legal form of marketing, it would be a lot easier for Coles and Woolworths to enter the market with their own cheaper, imported no-frills brands.

Being done over by Coles and Woolies? Couldn't happen to a nicer bunch of blokes.

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East moves west - more than a miner miracle

You'd need to be living under a rock not to have heard that the world's centre of economic gravity is moving from west to east - towards us. But most of us are yet to appreciate the full ramifications of this change in the globe's economic geography.

The shift is occurring because of the re-emergence of China and India as major economic powers. Why re-emergence? Because in the 18th century - before the West's industrial revolution - the two accounted for almost half of gross world product.

By 1990, China and India's share of world gross domestic product was down to less than a 10th. Today it's about a fifth and expected to be more than a quarter by the end of this decade. By 2030 it may be as much as a third.

Everyone knows the rapid industrialisation and urbanisation of these two countries is the cause of our present resources boom. But as Treasury points out in its annual sermon (otherwise known as budget statement No. 4), there's more to it.

''As China and India continue to develop, the growing cities now driving demand for Australia's mineral resources will be populated by an increasingly wealthy and upwardly mobile middle class, with incomes and tastes to match,'' Treasury says.

''Increasing consumer purchasing power and changing spending patterns will open up new, often unforeseen, opportunities for Australia - well beyond those flowing from the current mining boom.''

One study has estimated that the number of middle-class consumers in Asia could increase by more than 1.2 billion people by 2020. If so, these projections would mean that by the end of this decade Asia would have more middle-class consumers than the rest of the world combined, with China surpassing the United States as the world's single largest middle-class market in terms of dollars.

By 2030, with India following China's lead, the world could have gone from mostly poor to mostly middle class, with two-thirds of the world's middle-class consumers living in our region.

(Like all projections by economists, this one confidently assumes the natural resources and ecosystem services needed to make this possible will be readily obtained - presumably, from another planet. But let's not allow ecological realities to spoil our happy economic analysis.)

In poor countries, spending on basic goods typically accounts for quite a high share of GDP, with household incomes barely covering the necessities of life. Then, in the early stages of economic development, a surge in investment spending causes consumption's share of GDP to fall quite sharply.

In time, however, continued growth allows a larger middle class to devote more money to purchasing luxury goods and services, both in absolute terms and as a share of household spending. As a result, consumer spending's share of GDP recovers as economies reach middle-income status.

China's consumption-to-GDP ratio has declined markedly in recent decades, reaching a low of only 35 per cent in 2009. (Our proportion is about 55 per cent, which is lower than it used to be because of our much higher investment in new mining capacity.)

But China is fast approaching income levels where consumption often turns, and the Chinese government is focused on reforms to foster higher growth in household incomes and to rebalance the economy towards domestic demand. So Treasury says there's considerable scope for a strong rise in the consumption ratio in the medium term.

We know from the earlier experience of countries such as Japan and South Korea in travelling down this road that as the amount of consumer spending grows its composition changes. As they become more affluent, people devote a higher proportion of their spending to services and consumer durables.

The early stages of such a shift are already evident in China. Since the early 1990s, its urban households have devoted a declining proportion of their spending to food and increasing proportions to medical services, transport and communication, and education, recreation and culture.

If you divide urban households into four groups according to their incomes, you find that, as incomes rise, households devote smaller and smaller proportions to food, and bigger and bigger proportions to services.

Urban households constitute a large and growing proportion of China's 400 million households (Australia has 8.5 million). Just over the past 10 years, the proportion of urban households owning a car has gone from virtually none to 12 per cent. The proportion owning microwave ovens has gone from 16 per cent to 58 per cent.

And get this: the number of computers owned per 100 households has gone from eight to 70, while the number of mobile phones has gone from 16 to 188. So ''new technology'' goods are spreading faster than household appliances.

On the ladder of goods and services to which people with growing incomes aspire, after consumer durables come culture, tourism and advanced education.

On overseas tourism, China and India's sheer population size mean they're starting to overtake those countries formerly dominant in providing tourists, the US, Britain and Japan. In 1995, about 4.5 million people from mainland China and 3 million from India travelled abroad for business and leisure.

By 2009, China's travellers had increased tenfold to 48 million, meaning it was close to catching up with the US and Britain. India had experienced a three- to four-fold increase to 11 million travellers a year.

And all this before the rise of the middle class has really got going.

Australia, of course, is already getting its cut. China and India's share of our education exports has risen sharply. China's share of our wine exports is now five times larger than it was five years ago. Tourist arrivals from China have more than trebled in the past decade - overtaking Japan in 2008-09 - and are catching up with those from the US.

Of course, not all the opportunities created by Asia's rising middle class will fall within areas of our comparative advantage. And to maximise even those opportunities that do fit our bill we'll need to continue to change and innovate. Competition with other countries will be fierce. As their own education systems improve, a smaller proportion of Chinese and Indians may seek education abroad.

And Treasury says it's not possible to forecast the exact mix of goods and services that will be demanded, let alone the shape of the global economy that will best service these demands. You can say that again.

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