Thrift paying big dividends on current accounts

The nation's econocrats have been pondering the resources boom for years, but one thing they've been expecting isn't coming to pass: we're not getting huge deficits on the current account of the balance of payments.

Last week's figures showed a deficit of just $5.3 billion for the June quarter, about half what it was in the March quarter. This included a surplus on the balance of (international) trade in goods and services of

$7.5 billion - the fifth quarterly surplus in a row - offset by a deficit on net income payments (our payments of interest and dividends to foreigners less their payments to us) of $12.8 billion.

Switching to the year to June, the current account deficit was $33.6 billion, down from $53.3 billion the year before. Expressed as a proportion of gross domestic product, this was an amazingly low 2.4 per cent, down from 4.1 per cent the year before.

So why were the econocrats expecting bigger deficits? Because most of the money to finance the surge of investment in new mines and natural gas facilities would have to come from foreigners, thereby adding to the surplus on the capital account of the balance of payments which, with a floating currency, is always exactly balanced by a deficit on the current account.

And why haven't the big deficits come to pass? Because household saving has been a lot greater than the econocrats were expecting. The more the nation saves, the less it has to call on the savings of foreigners to finance its investment spending.

Last financial year's current account deficit is down because saving is up while the mining investment boom is only just getting started.

As that boom gets under way, the current account deficit is likely to grow. This year's budget forecast a deficit of 4 per cent of GDP for this financial year, rising to 5.25 per cent in 2012-13. Even so, those figures are smaller than the econocrats had been expecting before they realised how much more households were saving.

Last week's national accounts showed households saving a net (that is, after allowing for the year's depreciation in the value of household assets) 10.5 per cent of household disposable income. This is unlikely to be an aberration; it's more likely to be a reversion to our earlier thrifty habits.

If you're more used to thinking about the current account deficit in terms of exports and imports, I should explain that these days economists tend to look on the other side of the coin, which shows saving and investment.

The current account deficit equals the capital account surplus, which represents the net inflow of foreign financial capital to the Australian economy. As we've seen, we call on the savings of foreigners to finance that part of our investment in new physical capital than can't be financed by our own saving.

This net inflow of foreign financial capital allows us to import more goods and services than we export, including imports of capital equipment.

The net capital inflow also helps us finance our net payments of interest on the nation's net foreign debt and our net payments of dividends on net foreign equity investment in Australia's businesses - though the ultimate justification for our foreign borrowing is the profits we make from our physical investments.

The nation's annual investment spending includes not just business investment in equipment and structures, but also public investment in infrastructure and households' investment in the construction of new homes.

Similarly, the nation's annual saving includes not just the amount saved by households, but also the saving companies do when they retain part of their after-tax profits rather than paying them all out in dividends and the saving governments do when they raise more in revenue than they need to cover their recurrent spending.

According to an article in the federal Treasury's latest Economic Roundup, in the decade or so before the first stage of the mining boom began in 2003, the current account averaged 3.7 per cent of GDP. During the first stage it averaged 5.7 per cent, but since the global financial crisis it's averaged 3.3 per cent.

Before the mining boom, gross national investment spending (that is, before allowing for the annual depreciation of assets) averaged 24.3 per cent of GDP. Since the start of the mining boom it's averaged 27.9 per cent.

Had the level of gross national saving stayed unchanged, that would have increased the average current account deficit by 3.6 percentage points. In fact, national saving has increased from 22.2 per cent to 24.5 per cent.

While households have been saving a lot more in the period since the global financial crisis, federal and state governments have fallen into operating deficit, meaning they've gone from saving to dissaving. As they get their budgets back to operating surplus in the next year or two they'll be adding to rather than subtracting from national saving.

Company profits have been high in recent years and many companies have been saving a fair bit. Mining companies, in particular, have been reinvesting a lot of their after-tax profits in expanding their activities. (To the extent that those retained earnings are owned by foreign shareholders, and were initially counted in the balance of payments as capital outflows, their reinvestment is counted as foreign capital inflow, even though the actual dollars never left the country.)

Australia's persistent current account deficit has always reflected a high rate of national investment rather than a low rate of national saving. Although our household saving rate was quite low during the decade or so to the mid-noughties, our overall, national rate of saving has been around the average for the developed economies.

Point is, should our current account get a lot bigger in the next few years, it will be because the mining construction boom involves a lot more investment spending, not because we're saving less.

We've done much hand-wringing lately about ''the cautious consumer'' (especially when we imagined consumer spending was weak, which we learnt last week it isn't), but the fact that increased household saving has stopped the strong growth in household income translating into booming consumer spending has some big advantages.

If we can avoid a consumption boom occurring at the same time as an investment boom, the Reserve Bank won't need to increase interest rates as much to control inflation and this, in turn, will avoid adding upward pressure to the Aussie dollar.

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Terrorism. A vast cost of feeling a little more secure

Now the 10th anniversary of the terrible events of September 11, 2001, has passed, it's time for plain speaking.

You've often seen me criticise economists for their bloodless rationalism - their excessive focus on efficiency in the satisfaction of our material wants and neglect of our emotional and social needs. Yet it's possible to go too far the other way, to be too emotional and not sufficiently hard-headed in our reaction to events.

And that's just what we've been in our response to the destruction of the World Trade Centre towers. We've exaggerated the threat from terrorism and spent far more than is sensible in trying to reduce it.

As usual, we have better information on the Americans' response than on our own, similar response. But there's much to learn from a study of the American experience by John Mueller, a professor of national security studies at Ohio State University, and Mark Stewart, a professor of civil engineering at our own University of Newcastle.

In the months after September 11, it was almost universally assumed the events represented not an aberration but the start of a new era of greatly increased terrorist threat. Intelligence sources estimated there were as many as 5000 al-Qaeda operatives in America.

So, like we did, the Americans hugely increased their spending on security. They established a new Department of Homeland Security and, in the time since then, increased spending on homeland security by a cumulative $US360 billion ($348 billion). They increased spending on federal intelligence by a cumulative $US110 billion, while state and local governments increased their spending by the same amount. The private sector's increased spending on security measures is estimated to be similar.

All that totals $US690 billion. Now Mueller and Stewart add the opportunity costs of terrorism insurance premiums, passenger delays caused by airport screening, the value of lives lost because people drove to their destination rather than suffer airport delays, and other losses in consumer welfare.

That totals $US420 billion, taking the grand total additional cost since 2001 to well over $US1 trillion.

Those figures don't include the cost to US taxpayers of the terrorism-related wars in Iraq and Afghanistan. The equivalent figure for Australia (which does include the cost of the wars) is about $30 billion.

The question people often ask is, are we safer? That's a silly question. Of course we're safer. The posting of a single security guard at the entrance to one building makes us safer, if only microscopically.

The sensible question is, are the gains in security worth the amount we're paying? Or, in the words of one risk analyst, "How much should we be willing to pay for a small reduction in probabilities that are already extremely low?"

The fact is, despite the escalation in our fear of terrorism, and despite the considerable publicity given to cases where the authorities have foiled bungling terrorist intentions, there's been no great increase in terrorist attacks outside war zones.

In 2005, after years of well-funded sleuthing, the FBI and other investigative agencies admitted that they had been unable to uncover a single al-Qaeda sleeper cell anywhere in the US.

So any terrorist threat derives from small numbers of home-grown people, often isolated from each other, who fantasise about performing dire deeds and sometimes receive a bit of training and inspiration overseas.

Home-grown Islamist potential terrorists are estimated to represent one in every 30,000 Muslims in the US. Muslim extremists have been responsible for a 50th of 1 per cent of the homicides committed in the US since 2001.

Around the world, the number of people killed since 2001 by Muslim extremists outside of war zones is 200 to 300 a year. That's 200 to 300 people too many, of course.

But it's less than the number of people in the US who drown in bathtubs each year.

The increased delays at US airports because of new security procedures have prompted many people travelling short distances to drive rather than fly.

But driving is far riskier than air travel and the extra road traffic is estimated to result in 500 or more extra road deaths each year.

More than 100 Australians have been killed by terrorists since 2001. But all of them have been overseas, the majority in the Bali bombing of 2002. There have been no terrorist attacks in Australia, though our security agencies claim to have foiled four "mass casualty events".

Stewart says the risk of an Australian being killed in a terrorist attack is one in seven million each year, which is about the same as the risk of being struck by lightning.

Why have we spent such huge sums trying to reduce such a small risk? And why have governments paid so little attention to whether we're getting value for money, especially at a time when budgets are tight and so many worthier causes are going begging?

Partly because we demand it of them. As someone said, "we have come to believe that life is risk-free and that, if something bad happens, there must be a government official to blame". Apart from the desire of security forces and spooks to work in a growth industry, politicians face distorted incentives. It's safer to spend more and risky to spend less.

Osama bin Laden's stated goal in launching his attack and threatening more was to lead the US into bankruptcy. He didn't succeed, but he has provoked a reaction that's contributed significantly to the US government's severe budgetary problem, which seems likely to cripple the American economy for the rest of the decade.

Meanwhile, we're left with security measures at airports and elsewhere that do more to inconvenience the public than the terrorists and amount to little more than security theatre.

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Rising unemployment more puzzle than worry

The unemployment rate has risen by 0.2 percentage points for two months in a row. Taken at face value, that says the economy is rapidly heading into recession. But it's always a mistake to take economic statistics at face value and, fortunately, the truth is likely to be far more reassuring.

The trick to using economic indicators to understand what's happening in the economy is not to overreact to the latest reading from one indicator. The new figure has to be put into the context of the particular indicator's trajectory and the general message coming from all the indicators.

Some indicators are more important than others. The quarterly national accounts - the centrepiece of which is gross domestic product - are the most important because they constitute the summation of a host of ''partial indicators''. GDP may be a poor guide to the nation's overall well-being, but it's a good guide to the outlook for income and jobs.

The monthly figures for employment and unemployment are very important because that's one of the main things we expect the economy to do for us: generate jobs for all those who want them.

The next question to ask when you get a new reading from an indicator is: how reliable is it? The job figures are based on a rotating sample survey, meaning they're subject to sampling error (as well as a lot of opportunity for other, human errors).

They tend to bounce around from month to month for reasons you can never put your finger on, but which don't reflect the more stable reality of the labour market. The national accounts also bounce around and are subject to heavy revision as more reliable data come to hand.

So both the key indicators are a bit ropey, and economists often use one as a check on the other. We know from last week's national accounts that, though natural disasters caused the economy to go backwards in the March quarter, it bounced back strongly in the June quarter and will recover further over the rest of the year as flooded coalmines get working again.

Last week's jobs figures told us that national employment - which totals 11.4 million - fell by 4000 in July and 10,000 last month. These are trivial amounts; they're saying not that employment is falling, but just that it's not growing. Trouble is, we need employment to keep growing because the population of people wanting jobs keeps growing. We need employment to grow by about 10,000 a month just to hold the rate of unemployment steady. Fortunately, this is less than half the rate of employment growth we needed a year or two ago because the rate of growth in immigration is now so much lower.

Note, unemployment has risen not because people are losing their jobs, but because additional jobs aren't being created. As a general proposition, we need the economy to be growing steadily because that's what creates additional jobs. Stepping back to view a longer run of figures, we see that employment was growing very strongly until November, since when it's shown virtually no growth. Though the economy contracted sharply in the March quarter, this contraction was weather-related and concentrated heavily in mining. And, as we've seen, the economy grew strongly in the June quarter.

So the pattern of growth in employment isn't easily reconciled with the pattern of growth in production (GDP). We need to examine the jobs figures to see how robust they are.

One way to see if there may be problems with the rotating sampling process is to look at what's happening to the ''matched'' sample (the part of the sample that's unchanged from one month to the next). Kieran Davies, of the Royal Bank of Scotland, has done this and finds that ''smoothed matched-sample employment is growing at 17,000 a month, while headline employment is broadly flat''. Hmmm.

Examining the breakdown of the (headline) employment figures shows the weakness is heavily concentrated among men rather than women. It also shows the problem is concentrated in Queensland (where in two months the unemployment rate has risen 0.9 percentage points to 6.2 per cent) and Western Australia (where in one month the unemployment rate has risen 0.4 percentage points to 4.4 per cent).

I don't trust those figures. But if you take them literally, both they and the national accounts are saying the precise opposite to the conventional wisdom about the ''two-speed economy'': all the weakness is in mining and the mining states, while all the strength is in the so-called non-mining economy.

But here's another puzzle. While there's been no growth in the number of people employed this year, the total number of hours worked has been rising solidly, with average hours per worker rising from 34.7 to 35.6 hours a week.

As Davies has argued, this sort of behaviour by employers - where they work existing staff harder rather than employing more workers - is what often happens when the economy is recovering from a recession and the media is wringing its hands over ''jobless growth''. It may be that, fearing skilled labour shortages, employers stocked up with workers last year, but this year they're not hiring any more until they need to.

The forward indicators of employment (job ads, vacancies etc) are weaker than they were, but still not weak. And the outlook is for strengthening GDP growth over the rest of this year, with the Reserve Bank's forecast of 3.25 per cent growth over the year to December still in with a chance.

So whatever the job figures are telling us, it's not that we're sliding rapidly towards recession - even in the so-called non-mining economy.

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A dose of reality for people who profit from doom

It's good news week - rumours of the impending death of the economy turn out to be greatly exaggerated. The national accounts for the June quarter provide a salutary lesson on how far popular perceptions can drift from reality.

Three months ago we were told real gross domestic product contracted by 1.2 per cent in the March quarter. This week we're told the contraction was a quarter less than that: 0.9 per cent.

That contraction was fully explained by the temporary effect of floods and cyclones. This week the temporary nature of that setback was confirmed - the economy rebounded to grow by 1.2 per cent in the June quarter.

Note that part of this rebound is purely arithmetic: had the economy not gone down in the March quarter it wouldn't have come back up as much in the following quarter. So it would be mistaken to imagine the economy was travelling at the annualised rate of 4.9 per cent (roughly, 1.2 x 4) in the quarter.

Despite the clearly temporary nature of the contraction, it fed into an increasingly negative mood about the state of the economy. The retailers were doing it tough because consumers were worried about so many things - the carbon tax, interest rates, uncertainty about the North Atlantic economies - and so were saving rather than spending.

You could see this from the way the indicators of consumer confidence kept falling. As part of this consumer caution, not many people were buying new homes.

Then there were the manufacturers doing it tough and laying off workers because of the very high dollar.

In short, the miners and the mining states might be coining it, but all the rest of us in the ''non-mining economy'' were just about stuffed. Turns out most of that was nonsense. Some of it was true - the retailers and manufacturers are doing it tough and housing activity is weak - but those three sectors account for less than 20 per cent of the economy, not the 90 per cent that is the so-called non-mining economy.

The rest we imagined. The media did its usual thing of trumpeting the bad news and playing down the good news but this fell on unusually fertile ground, to mix a few metaphors. The Gillard government's doing a terrible job, therefore the economy's stuffed. That's logical, isn't it?

This week we got a bulletin from the real world. Turns out that though real retail sales grew by just 0.3 per cent in the quarter and 0.6 per cent over the year to June, real consumer spending grew by a healthy 1 per cent in the quarter and a bang-on-trend 3.2 per cent over the year.

Huh? How did we get it so wrong? Well, we took too much notice of the retail sales figures simply because they come monthly, forgetting they account for only about 35 per cent of total consumer spending.

Retail sales cover mainly goods - what they don't cover is mainly services. In recent times our spending preferences have shifted away from goods and towards services. When that happens, the retail sales figures give you a bum steer.

Our other mistake was to take too much notice of the fall in consumer sentiment. It proved a dodgy guide to actual consumer spending. Both these things have tricked us many times before.

The punters know no better and, though it pains me to admit it, the media have a vested interest in not querying a bad-news story. But there's no excuse for the business economists - for them it's professional incompetence. Proof they're not as rational as their model assumes all of us are and not impervious to the popular perceptions around them, as their model also assumes.

This week's figures also reveal a tiny fall in the rate of household saving to 10.5 per cent of household disposable income. Though the ratio is notoriously volatile, this raises the possibility that households have got their rate of saving up to where they want it.

This, in turn, raises another point of arithmetic - it's not a high rate of saving that causes weak growth in consumer spending, it's an increasing rate of saving. Once the rate has stabilised, consumption must grow as fast as household disposable income is growing.

And despite all the phoney I-know-you're-doing-it-tough rhetoric coming as both sides of politics feed back the whinges they hear from their focus groups, the accounts confirm household income is growing particularly strongly - by a nominal 7.5 per cent over the year, way ahead of inflation.

That strong growth comes from a combination of healthy growth in employment (more household members with jobs) and somewhat excessive growth in real wages given our weak rate of productivity improvement.

Both factors are evidence most of us aren't doing it tough.

Part of the narrative of the resources boom is that growth will come more from business investment spending (as we build a lot more mines) than from consumer spending. That wasn't true this quarter. Why not? Not because business investment was weak - it wasn't - but because consumer spending was both strong and accounts for a much bigger share of GDP than investment does.

The other side of the non-mining-economy-is-stuffed proposition is that pretty much all the growth in the economy is coming from the mining sector. As a general proposition, there's no doubt the mining, mining-related and heavy construction industries are growing strongly. But, according to the accounts, that wasn't true in the June quarter. As Kieran Davies, of the Royal Bank of Scotland, has pointed out, with the output of mining proper going backwards during the quarter, the output of the so-called non-mining economy grew by 1.3 per cent, more than accounting for the growth of 1.2 per cent overall.

That's the bit people have convinced themselves is stuffed.

Why isn't mining growing? Because a lot of the flooded Queensland coalmines are still not back to production. But this, of course, is temporary. As they come back on line in the second half of this year they'll give GDP a one-off boost.

You have to be careful not to read too much into the quarterly national accounts, which are subject to frequent revision.

But you have to be even more careful not to be misled by those who cry loud and long about how tough things are. They're probably exaggerating (or being exaggerated by a bad-news obsessed media) while those who are doing fine say nothing.

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THE DUMBING DOWN OF THE PUBLIC POLICY DEBATE

Gruen Lecture series, Australian National University
September 8, 2011

I’m delighted to be taking part in this lecture series to honour my old friend Fred Gruen. I still regret his passing, even though his two sons just about fill the vacuum he left.

Oldies have always lamented that things aren’t as good as they used to be, but I don’t think there’s any reason to doubt the widespread perception that the debate - or ‘discourse’ as the fashionable academics say - about politics and public policy has become a lot less intellectually satisfying. If Fred were to come back and take up today’s newspapers, I don’t doubt he’d notice the difference. It’s got worse since the arrival of the Rudd-Gillard government, and worse again since Tony Abbott became opposition leader. But I suspect it would be a mistake to attribute too much of the deterioration to the actions of particular individuals. And, in any case, I’m sure the rot set in a lot earlier than 2007 or 2009. We’re dealing with a deteriorating trend that has been running for many years.

I could regale you with the worst examples of the way the debate has dumbed down - the preoccupation with Julia Gillard’s appearance, Kristina Kenneally’s decision to let her hair grow out, Tony Abbott’s decision hardly to mention the budget in his budget reply speech - but I’m more interested in trying to explain why the dumbing down has come about. Suffice to say that evidence of the phenomenon can be found in the increased emphasis on ‘race-calling’ in political reporting (who’s winning, who’s losing; who’s up, who’s down), on personalities, trivialities, scandals and accusations, slogans and name-calling rather than reasoned debate.

Lindsay Tanner offered his explanation in his book Sideshow: Dumbing Down Democracy. He argues it’s pretty much all the fault of the media, which is under siege from commercial pressures and technological change. Since the politicians must use the media to communicate with the electorate, they’ve had little choice but to dumb down their message to meet the media’s demands. The Canberra press gallery’s response to this thesis was predictably defensive, passing a lot of the blame back to the pollies. So, which side is to blame? Well, here a bit if economic training comes in handy: to be convincing, any explanation of some development has to provide reasons from both the demand side and the supply side. In other words, I think we can share the blame roughly evenly between the media on the demand side and the pollies on the supply side.

Let’s start with the media. And let me start by observing that much of the media has always been pretty dumb. The tabloids have always been tabloid and the commercial electronic media - radio and television - have never been terribly earnest in their coverage of politics. I think it’s true, however, that the tabloids have become dumber over the years: more hyped up, more inclined to emotional outbursts than factual reporting. Even so, when people complain about the debate dumbing down, I suspect most of their complaints relate to what they read in the quality press - or on the quality press’s websites.

In my 37 years in journalism I’ve been particularly conscious of the way old professional standards - being a paper of record, strict separation of news and opinion, the avoidance of subjects considered sordid - have given way to more overt commercial considerations. Part of this I attribute to microeconomic reform, especially deregulation of the capital market, which has intensified competition in general and, in particular, the sharemarket’s scrutiny of the adequacy of the newspaper companies’ profit performance.

For many years newspapers have faced steadily intensifying competition from other media. For as long as I’ve been in this business newspapers have worried about their circulation figures, which have been falling heavily relative to population growth and, more recently, have been falling in absolute terms. This I take to be explained by the increased competition they face from the ever-growing list of other ways for people to spend their leisure time. Television long ago became the main way people get their news, and the rise of talk radio and radio talkback was pinching our customers long before the arrival of the internet, with its multitude of alterative news sources, including the newspapers’ own websites.

Evening television news bulletins and breakfast radio programs were stealing the thunder of morning newspapers long before the internet began delivering ‘breaking news’ to people in their offices throughout the day. Because the electronic media and the new media are so much better at breaking news, the media have been feeding the public’s natural impatience to know the very latest. But breaking news gives primacy to immediacy over meaning. It’s undigested news - often unable to give an adequate account of what happened, let alone how it happened and why. Breaking news is dumbed-down news.

A related phenomenon is the long-emerging 24-hour news cycle, which has been reinforced by the arrival of 24-hour news radio and television channels. This increased output of news greatly increases the demand for news items and for new news items as the day progresses. It has the effect of shortening attention spans and it may well be that increased quantity comes at the expense of quality reporting and commentary. Speaking of attention spans, television and radio news stories are getting briefer, with the grabs of ‘actuality’ from politicians getting ever shorter. Politicians are able to repeat slick slogans without having to elaborate or defend them.

The arrival of the internet poses a considerable threat to the survival of newspapers - particularly the quality press - as they lose the formerly highly lucrative classified advertising and some display advertising, but also lose readers -particularly younger readers who prefer to read our offerings on the net, on tablets or on smartphones.

With all these pressures, is it surprising newspapers are trying to attract more readers by making their news more entertaining and, in the process, dumbing it down? Journalists have long understood that people prefer stories - narrative - to analysis, and stories about people rather than concepts. News has always been a combination of the important and the interesting, so the news media have responded to increased competitive pressures by increasing the interest component at the expense of the importance component. They have personalised politics by focusing on individuals, particularly leaders, making it more presidential. They have increasingly covered politics as though it was a spectator sport rather than policy debate. They have made the news more exciting by focusing on conflict and controversy rather than reasoned debate. They have made the news more entertaining by focusing more on gaffes and gimmicks. They have always understood that their audience finds bad news more exciting than good news, but they have stepped up the search for bad news, allowing it to crowd out the reporting of straight news about the facts of policy proposals. They spend most of each parliamentary term demanding the opposition produce its policies, but then devote little attention to those policies when finally they are produced.

Newspaper websites are often much dumber than the papers themselves, with a lot of perfunctory news stories, sexy photos, gimmicky stories and stories about celebrities. This is partly because the internet audience is much younger and also because the online editors get real-time feedback on what people are clicking on, and what they click on is sexy photos and stories about celebrities. The better informed editors are about the customers’ ‘revealed preference’, the harder it is to feed them material they feel would be better for them.

I believe the advent of talkback radio has had a big influence on politics and political reporting. It is very much news as entertainment, particularly the engendering of indignation about the claimed failures of officialdom. Shock jocks have broken down earlier conventions about subjects considered off-limits, particularly those with xenophobic or racist overtones. This has affected the behaviour of other mediums - particularly the tabloids - and the politicians. The electronic media and the tabloids do much to cater to - and amplify - the public’s worries about crime. Once, the quality press avoided dwelling on the gruesome details of particular crimes, but in its efforts to attract and retain readers it now devotes a lot more space to crime reporting. Television thrives on colour and movement. If it bleeds, it leads. Television is well suited to covering natural disasters, and the print media have met this competition despite their disadvantage, leaving less room for politics and policy. The extended coverage of natural disasters is a form of voyeuristic entertainment. For completeness I should record that, over the years, the broadsheet papers have come to include a lot of overt entertainment, in the form of ‘lifestyle’ sections on television, food, fashion and weekend gig guides.

So the media have certainly played a major part in the dumbing down of the policy debate. But the politicians have also played a big part. Just as the media’s commercial imperative has become more dominant, so I believe the politicians have, in their own way, become more commercial. They’ve always sought to balance the conflicting goals of using power to make the world a better place and staying in office because it’s nice to be in charge. I think politicians on both sides now put a lot more emphasis on attaining and retaining office than on ensuring they use their time in office to achieve improvements. On the Labor side, but increasingly also on the Liberal side, politics is becoming a professional career structure, where you start out from university as a union or ministerial factotum, eventually working your way to the top of elected office. You become steeped in the backroom, cynical side of the game of politics - learning the tricks of attaining and retaining office - without gaining much experience of the outside world or, it seems, acquiring many deeply felt convictions about how the world needs to be changed.

Politics has also become more commercial - more professional, more scientific - with its increasing resort to the techniques of marketing and market research. In the old days politicians could only guess from personal contacts and experience how the policies they were pursuing would be received by the electorate of polling day. It was easier to convince yourself that something you really wanted to do would go down well. These days, opinion polls and focus groups leave both sides in little doubt about exactly what voters are thinking and feeling about particular policies. Note, however, that these things give the public’s opinions a constancy and stability they don’t possess. In earlier times, qualitative research was use to help politicians shape arguments to sell the policies they wished to introduce; these days, the lifetime professional-career approach to politics makes it a lot more tempting to use qualitative research to decide what your policies should be.

It also makes it tempting to confirm to the media’s whims if that’s what’s needed to connect with the electorate. Politicians now spend a lot more time inspecting disaster sites, getting in on the story, demonstrating their authority and their concern - and otherwise wasting time. Politicians and their bureaucrats devote a lot of time to coming up with minor ‘announceables’ to feed to the ever-demanding 24-hour news machine and fixing the problems of particular individuals whose case attracts the media’s attention.

Even so, it’s misguided to see politicians as innocent victims of the demanding media machine. To a great extent the media are open to being used as a tool by governments and interest groups. All governments and oppositions see ‘media management’ (read, manipulation) as a major part of the successful performance of their jobs. I don’t believe it was merely to oblige the media that politicians moved to a presidential style of politics; it suited the politicians’ marketing objectives just as it suited the media’s needs for personalisation. Similarly, it’s the politicians who choose to humanise themselves by being accompanied by their spouse and children on the campaign trail or being interviewed at home by a women’s magazine. Politicians and interest groups happily exploit the media’s disinclination to critically examine claims that are bad news before shouting them from the rooftops, such as that some proposed government measure will destroy 10,000 jobs. In moments of weakness some politicians have explained that keeping the media regularly fed with minor announceables keeps them too occupied to have time to go digging for their own, possibly less favourable stories.

Politicians have long understood that, in politics, the perception can be just as important as the reality. Their new-found access to knowledge of exactly how the public perceives policy questions can tempt them to concentrate on manipulating perceptions while neglecting to attend to the reality of government performance - which, if allowed to deteriorate too greatly, won’t fail to register on the public’s perceptions about a government’s competence.

I suspect the growing careerism in politics has caused the fight for office to become more intensely competitive, prompting politicians to seek short-term advantage at the expense of their profession’s long-term credibility with the electorate: to be more willing to make and break election promises, find deceptive ways of expressing things and take the fight into areas formerly held by tacit agreement to be off-limits, such as immigration and asylum seekers. The politicians themselves must accept most of the blame for this aspect of the dumbing down of the policy debate.

But let me finish by saying that, in some ways, the media discussion of politics and policies is richer than ever before. As part of its effort to compete with the greater immediacy of the electronics - and perhaps also in response to a much better educated and more economically literate audience - the quality press devotes a lot more space to commentary and analysis than it used to, and only a portion of this is the mere assertion of intemperate opinions. Much of it is analysis of policy issues by specialist journalists or academics. Then we have the media’s opinion websites, plus the universities’ The Conversation website, and any number of blogsites - both local and international - where academics and other erudite souls debate policy issues at a level of sophistication much higher than in any newspaper. The politicians themselves may not be conducting a very edifying policy debate, but if that’s what you want you can find it without too much effort.

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NSW: Not all that different but clearly better

This is the I-solemnly-promise-to-be-tough budget. Its nasties come as an IOU. When the whole state had its tongue hanging out for deliverance from the Carr-Iemma-Rees-Keneally government, some wondered just how different and better Barry O'Farrell would be.

Now we have our answer. Not all that different, but clearly better. We hope.

Incoming governments usually cut savagely in their first budget, knowing all the nastiness can be blamed on their hopeless predecessors. But O'Farrell is a man of moderate convictions and modest ambition.

He's done enough - on paper, at least - to steer the budget back to surplus in the financial year after this, but not nearly enough to produce the ever-growing surpluses necessary to permit the greatly increased spending on infrastructure he says we need.

Truth is, this budget is remarkably similar to the budgets we had from Labor: full of resolutions to be pure, but not yet. It promises annual growth in recurrent spending of less than 4 per cent in the three years of the forward estimates, but 7.1 per cent in the budget year.

It promises the most minuscule operating surpluses in the three "out years" but a collapse into deficit (to the tune of $718 million) in the budget year, after a surplus of $1264 million in Labor's last year.

To be fair, most of that deterioration isn't the fault of O'Farrell and his Treasurer, Mike Baird. Of the total worsening of almost $2 billion, about 45 per cent is explained by the withdrawal of federal government stimulus spending and the standard, but misleading, accounting treatment of it in the state budget.

Another 45 per cent is explained by the expected deterioration in state revenues after the very recent slowdown in the economy.

But that leaves a worsening of $226 million put in by O'Farrell's hand, the net cost of all his unfunded election promises.

Of the promised spending savings of $8 billion over four years, much had already been announced by the Labor government. That's particularly true of the $6 billion in savings from imposing "efficiency dividends" on government departments.

One genuinely new measure is $800 million in savings from cuts in particular spending programs. It's these that could impose pain on particular parts of the community.

But no measures were announced in the budget because none has yet been decided. Only when they are, and the public has reacted, will we know whether O'Farrell has the steel to bring the budget back to surplus.

One savings measure where O'Farrell has admitted copying Labor is his intention to limit state employees' pay rises to 2.5 per cent a year plus the proceeds from agreed cost savings.

The trouble with Labor's budgets was that they never delivered on promised future savings. The donkey never got to eat the carrot.

The only hope for O'Farrell and Baird is that they will deliver. O'Farrell's willingness to enshrine his wages policy in law is a hopeful sign. But at this stage hope is all we can do.

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Politics of self-interest feeds the inner beast

Barring the start of World War III, we may never hear an Australian politician repeat John Fitzgerald Kennedy's unforgettable line, "Ask not what your country can do for you - ask what you can do for your country".

Nobility be hanged. There was a time when our leaders saw it as their job to bring out the best in their followers. These days, they see their best chance as pandering to our dark side - our fears, our weaknesses, our selfishness.

These days, self-centredness not only comes naturally, it's officially encouraged. On what basis should you decide which politician to support? The one that's offering you the best deal, of course.

Why do our leaders have such a low opinion of our motivations? Perhaps for the same reason people who lie a lot always expect other people to be lying. Despite their protestations to the contrary, most politicians seem motivated less by a burning desire to make the world a better place than by ambition for personal advancement. They simply assume we are like they are.

Then there's the influence of economists. The doctrine of economic rationalism not only assumes self-interest to be normal and altruism to be non-existent, it sanctifies self-interest as a civic virtue.

Adam Smith, founder of modern economics, said a lot of noteworthy things, but few are quoted more than this: "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages."

Be as selfish as you like because selfishness is what makes the economy work.

But here's a balancing quote from the great man that's much less often repeated: "How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it."

There are two sides to our nature; we do have our "better angels" as Abraham Lincoln put it, but at present our lesser selves are in the ascendancy.

Perhaps another influence on the politicians is their resort to the techniques of marketing to further their pursuit of power. Marketers have no hesitation in appealing to our envy, lust or greed.

In their world, use of the word "indulgence" is taken to be enticing, not a condemnation. "You deserve it" and "because you're worth it", advertisers assure us. My favourite is an ad for a cinema candy bar: "in the dark, no one can see you". Go ahead, guts yourself.

Marketers use focus groups to test products and make sure they're giving the customers exactly what they want. Politicians use them to make sure they're telling voters exactly what they want to hear.

At least since John Howard's last days, people in focus groups have been complaining about the rising cost of living. Really? That's a new one. When the most people can do is complain about the cost of living it's a sign they've got nothing bigger to worry about. I suspect it's the product of our having gone 20 years without a severe recession. When you're worried about keeping your job, you don't complain about the cost of living.

And yet both sides of politics are perpetually echoing back to the electorate their professed concern about how tough times are. Tony Abbott's remarkably successful scare campaign against the carbon tax - it's actually not half as bad as the goods and services tax, and certainly far less disruptive than the effect of the high dollar on manufacturing and tourism - preys on people's worries about the cost of living.

When Howard was introducing the GST a lot of people's attitude was: "I don't like the sound of it one bit, but if you're insisting on it I suppose it must be in the best interests of the country." Much the same could be said of the carbon tax, yet far fewer people are saying it - nor are they being encouraged to think that way.

As it's understood by scientists, our preoccupation with our own interests usually extends to the protection of our own family. But there seems little sign of concern for the wellbeing of our children and grandchildren in the carbon tax debate. We've been encouraged to focus only on our immediate worries about balancing the household budget.

But for unbridled selfishness there could surely be no more egregious example than the success the licensed clubs have had in stirring their members' opposition to the Gillard government's reluctant championing of compulsory pre-commitment on poker machine use.

If ever there was an action that could be said to be "un-Australian", it's profiting from the addiction of gamblers and all the misery caused to them and their families. The killer statistic is this: according to the Productivity Commission, about 15 per cent of regular poker machine users contribute about 40 per cent of all the money put through pokies.

So the whole edifice of the licensed club industry rests heavily on the exploitation of a small minority of their own members. All the cheap meals and shows, all the grants to local sporting groups - much of that money is coming from the pockets of the spouses and children of problem gamblers.

But those fighting to keep their cheap meals mustn't feel guilty. You're only doing what our politicians, economists and advertisers urge you to do: putting your own interests ahead of other people's, including the less fortunate.

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Productivity weak, but that's not all bad

Before you get too panic-stricken about Australia's poor productivity record, consider this: maybe it's a good sign. If you've been given the impression productivity can be weak only for bad reasons, you've been misled. Productivity - output per unit of input - is only what you could call a key performance indicator; a means to an end, not an end in itself.

The end is the material well being of the Australian people. And there are plenty of things that improve our well-being (or ''welfare'' as economists call it) while worsening measured productivity.

This is an uncontroversial point among economists and has been acknowledged by the leading protagonists in the productivity debate, the secretary to the Treasury, Dr Martin Parkinson, and Saul Eslake of the Grattan Institute. But you have to read their fine print to find that acknowledgement.

The productivity of labour in the mining industry has declined by about 40 per cent since 2001-02, but that's mainly because much work is being done on the installation of additional production capacity, without that additional capacity yet coming on line and adding to output. When eventually it does, the industry's productivity will be much improved.

Another factor affecting mining is that the exceptionally high prices we're receiving for our minerals have prompted firms to mine lower-grade or harder-to-get-at ore. Is it a bad thing it's now economic to mine and sell second-grade minerals? Hardly - well, not from our standard materialist viewpoint.

Labour productivity has dropped by about a third in our utilities sector (electricity, gas and water). Electricity and gas businesses are investing heavily to expand their production capacity, replace ageing transmission infrastructure and meet renewable energy targets.

Similarly, governments have undertaken significant investment in water infrastructure - including desalination plants in five states - to guarantee security of supply during droughts.

Once again, none of these developments is bad, notwithstanding their adverse effect on measured productivity. The experts disagree on how much of the overall deterioration in productivity is accounted for by mining and utilities. Some say a lot of it.

But another factor contributing to our poor productivity performance is that, with an unemployment rate of 5 per cent or so for more than a year, we're close to full employment. This means firms are having to employ people who wouldn't be their first pick for the job, thereby lowering the average productivity of their workforce.

Is this a bad thing? On the contrary, it's wonderful the economy is in a position to provide work for these people. This, after all, is one of the main things we want from our economy: that it generate jobs for all those who want them.

It's possible something similar is happening to the productivity of our capital equipment. Some firms may be using whatever old or second-rate machines they can get their hands on so as to keep up with demand. Again, not such a bad thing.

I wrote some weeks ago that the big microeconomic reform push of the 1980s and '90s proved disappointing in its effect on productivity. It produced a once-off lift in the level of our productivity, but failed to achieve the lasting increase in our rate of productivity improvement.

But there was a different respect in which micro reform yielded a quite unexpected benefit: it made the economy a lot more flexible and resilient in response to economic shocks. By increasing the degree of competition in many markets, it reduced firms' pricing power (and hence their unions' bargaining power), thus making the economy significantly less inflation-prone.

In consequence, the macro economy became much easier to manage. Combine that with the authorities' adoption of more disciplined frameworks for the conduct of monetary and fiscal policies, and you probably have much of the explanation for our record of 20 years without a severe recession.

Is that a good thing? Of course it is. It's a remarkable achievement. But in economics everything has an opportunity cost and even good things have their drawbacks. It's highly likely the drawback of going for so long without a serious recession is an ever-weakening productivity performance.

As Dr Diane Coyle wrote in her book, The Economics of Enough, ''a recession is a period of faster industrial restructuring rather than simply an economy-wide reaction to a common shock''.

When times are good - and, despite our recent complaints, times have been very good for most of our businesses for many years - firms aren't under a lot of pressure to improve their performance. It often takes adversity to oblige firms to try harder and lift their game. Inefficiencies and unsuccessful projects can be overlooked when times are good. They tend to accumulate. But when times get tough there's a lot of spring cleaning.

So, as Coyle implies, structural change tends to occur in bunches at the time of recessions, rather than continuously as textbooks assume.

Of course, this process of ''creative destruction'' during recessions can be very painful, involving a lot of workers losing their jobs.

As a case in point, it's likely the adjustment being imposed on our manufacturers by the high dollar will leave productivity a lot higher in what's left of manufacturing. Many firms will really have to improve their performance if they're to survive.

So, not to worry. Sooner or later the economy will face another severe recession - the business cycle is far from dead - and once it has done its worst and we're into the recovery phase our productivity figures are likely to look much better.

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Is this time different?

When the Queen asked economists why so few of them had foreseen the global financial crisis, our professor Geoff Harcourt and some other academics petitioned her to say, among other things, that one reason was their profession's loss of interest in economic history.

That sad truth was demonstrated convincingly by two American professors, Carmen Reinhart and Kenneth Rogoff, in a book which has since become a modern classic, This Time Is Different: Eight Centuries of Financial Folly. It's just out in paperback, published by Princeton University Press.

In their landmark study of hundreds of financial crises in 66 countries over 800 years, Reinhart and Rogoff find oft-repeated patterns that ought to alert economists when trouble is on the way. One thing stops them waking up in time: their perpetual belief that ''this time is different''.

But, as we're witnessing at present, even when economists and financial market players have been hit over the head by reality, their ignorance of history stops them understanding what happens next. Wall Street and Europe fondly imagined the Great Recession was behind them, only to discover it's still rolling on.

Reinhart and Rogoff could have told them - did tell them - financial crises of this nature aren't so easily escaped. The Great Recession was so called to signify that another depression had been averted.

The authors say a more accurate name would be the Second Great Contraction. ''The aftermath of systemic banking crises involves a protracted and pronounced contraction in economic activity and puts significant strains on government resources,'' they say.

They show that, in the run-up to America's subprime crisis, standard indicators such as asset price inflation, rising leverage (debt relative to the value of assets), large sustained current account deficits on the balance of payments and a slowing trajectory of economic growth exhibited virtually all the signs of a country on the verge of a severe financial crisis.

So why did so few economists recognise the signs? Everyone thought this time was different.

''Our basic message is simple,'' the authors say, ''we have been here before. No matter how different the latest financial frenzy or crisis always appears, there are usually remarkable similarities with past experience from other countries and from history.

''Recognising these analogies and precedents is an essential step towards improving our global financial system, both to reduce the risk of future crisis and to better handle catastrophes when they happen.''

When looking for the root cause of the global financial crisis, a lot of people put it down to human greed. That's true enough, but it doesn't give us much to work on.

The authors' studies lead them to a different culprit: debt. Credit is crucial to all economies, ancient and modern. Progress would be a lot slower without it. So the point is not that credit is bad, but that it's dangerous stuff.

''Balancing the risks and opportunities of debt is always a challenge, a challenge policymakers, investors and ordinary citizens must never forget,'' the authors say.

But ''if there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by government, banks, corporations or consumers, often poses greater systemic risks than it seems during a boom.

''Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are.''

Such large-scale debt build-ups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short-term and needs to be constantly

refinanced.

Again and again, countries, banks, individuals and firms take on excessive debt in good times without enough awareness of the risks that will follow when the inevitable recession hits. Many players in the financial system often dig a debt hole far larger than they can reasonably expect to escape from, most obviously in the US in the late 2000s.

''Government and government-guaranteed debt ? is certainly the most problematic, for it can accumulate massively and for long periods without being put in check by markets ? Although private debt certainly plays a key role in many crises, government debt is far more often the unifying problem across the wide range of financial crises we examined.''

Financial crises are nothing new. They've been around since the development of money and financial markets. And they follow a rhythm of boom and bust through the ages. ''Countries, institutions and financial instruments may change across time, but human nature does not,'' they say.

Human nature brings us to the Achilles heel of debt: confidence. ''Perhaps more than anything else, failure to recognise the precariousness and fickleness of confidence - especially in cases in which large short-term debts need to be rolled over continuously - is the key factor that gives rise to the this-time-is-different syndrome.

''Highly indebted governments, banks or corporations can seem to be merrily rolling along for an extended period, when bang! - confidence collapses, lenders disappear and a crisis hits.''

We've come to believe sovereign debt defaults are unthinkable and extremely rare. This may be partly because ''a large fraction of the academic and policy literature on debt and default draws conclusions based on data collected since 1980''.

The book focuses on two particular forms of financial crises: sovereign debt crises and banking crises. The present global crisis began with failing banks and has now proceeded to the threat of sovereign debt default.

Which, having looked at more than a mere 30 years of data, we now discover is quite common. Had economists been researching the question with the diligence of Reinhart and Rogoff - who put most of their effort into assembling a massive database covering 66 countries for up to 800 years - they may have come up with a little statistic it would have been handy to know a bit earlier.

On average, government debt rises by 86 per cent during the three years following a banking crisis. And that's not the cost of the bank bailouts. It's mainly because banking crises ''almost invariably lead to sharp declines in tax revenues as well as significant increases in government spending''.

Had we known our history, it wouldn't have surprised us that, when you start with heavily indebted governments, a banking crisis soon leads to a sovereign debt crisis.

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Invest in children of knowledge revolution

It's annoying the way business people keep slipping the words ''going forward'' into almost every sentence and it was even worse when Julia Gillard kept repeating the slogan ''moving forward'' in the last election campaign. But I have to admit they've got the right idea: we do need to keep our minds focused on the future and what we need to do to secure it.

The world keeps changing and we must respond appropriately to that change. Most of us feel threatened by change, and it's only human to want to resist it. The temptation is to try to preserve things as they are, rather than adjust to the way they will be.

As we wonder what to do about the threat to our manufacturing industry, it's tempting to see that threat as temporary. We're in the middle of a resources boom which has lifted the value of our dollar to a level which could wipe out some of our industry. But the boom won't last long and, if we're not careful, we could find ourselves high and dry: no boom and a big chunk cut out of manufacturing. What do we do then?

This is a serious misreading of our situation. What we're dealing with isn't just another of the transitory commodity booms we've experienced many times before. It's a historic shift in the structure of the global economy as the Industrial Revolution finally reaches the developing countries. The two biggest countries in the world, China and India, which were also the biggest economies before that revolution, are rapidly industrialising and within the next 20 or 30 years will return to their earlier position of dominance.

Does that sound temporary to you?

As part of their urbanisation and industrialisation, those countries - and the Vietnams and Indonesias following in their wake - will require huge quantities of iron ore, coal and other raw materials. Not for several months but for several decades. Much of what they need will be coming from us. That says it's likely to be many moons before our dollar falls back to the US70? levels our high-cost manufacturers are comfortable with.

The other side of the re-emergence of China and India is the global shift of all but the most sophisticated manufacturing from west to east. This is a disruptive trend affecting all the developed economies, not just us. All the rich countries are having to find other things to do as their manufacturing migrates to the poor countries.

This, too, is not a process that's likely to stop, much less reverse itself. So it's not a question of hanging in until the world comes back to its senses and things return to normal. The day will never come when we're able to reopen our steel mills and canning factories.

It's a question of whether we dig in and try to prevent our economy changing, or we adapt to our changed circumstances and move into areas more suited to a rich, well-educated, highly paid economy.

In truth, we're making so much money from our sales of raw materials to the developing countries that we could afford to use a fair bit of that income to prop up our manufacturers. That wouldn't make us poorer, just less prosperous than we could be (though keeping labour and capital tied up in manufacturing would mean a lot more immigration and foreign investment to meet the needs of our rapidly expanding mining sector).

And the fact is that, throughout most of the 20th century, we diverted a fair bit of our income from agriculture and mining to subsidising our then highly protected manufacturing sector. This may help explain why so many people - particularly older people - are so ready to do whatever it takes to stop factories being closed. It's the traditional Australian way of doing things: passing the hat.

But what's the positive, future-affirming alternative? What else can we do?

Embrace the newer revolution in the developed world, the Information Revolution. While the poor countries are becoming manufacturing economies, the rich countries are becoming knowledge economies.

The knowledge economy is about highly educated and skilled workers selling the fruits of their knowledge to other Australians and people overseas. It covers all the professions and para-professions: medicine, teaching, research, law, accounting, engineering, architecture, design, computing, consulting and management.

Jobs in the knowledge economy are clean, safe, value-adding, highly paid and intellectually satisfying.

The developed economies are fast becoming ''weightless'', as an ever smaller proportion of income and employment comes from making things and an ever increasing proportion comes from providing services. Some of those services are fairly menial, but the fastest growing categories involve the highest degrees of knowledge and skill.

Employment in Australian manufacturing has been falling since the 1980s. It's sure to continue falling whatever we do to try to prop it up. By contrast, since 1984 total employment has grown by almost three-quarters to 11.4 million. Get this: all of those 4.8 million additional jobs have been in the ''weightless'' services sector.

Notwithstanding our future increase in the production of rural and mineral commodities, our economy - like all the rich economies - will continue to lose weight. The real question is whether the services sector jobs our children and grandchildren get will be at the unskilled or the sophisticated end of the spectrum.

And that depends on how much money and effort we put into their education and training. We've gone for the past two decades underspending on education and training at all levels, falling behind the other rich countries.

If we've got any sense, we'll use part of the proceeds from the resources boom to secure our future in the global knowledge economy.

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Sustainable well-being

What does federal Treasury believe? What are the values that underlie the strong line it takes in its advice to governments? A lot of people think they know, but this week its newish boss, Dr Martin Parkinson, spelt it out in an important speech.

And some of the people who think they know all about the ''Treasury line'' may be surprised. Parkinson's title was ''Sustainable well-being'' .

What does he mean by well-being? It's ''what we in the Treasury think of primarily as a person's substantive freedom to lead a life they have reason to value'', he says.

What does he mean by sustainability? ''Sustainable well-being requires that at least the current level of well-being be maintained for future generations.

''In this regard, we can consider sustainability as requiring, relative to their populations, that each generation bequeath a stock of capital - the productive base for well-being - that is at least as large as the stock it inherited.''

But because well-being is a multi-dimensional concept, he says, going well beyond material living standards - and even the environment - we can see that the stock of capital should include all forms of capital, of which there are four.

First, physical and financial capital: the value of fixed assets such as plant and equipment and financial assets and liabilities.

Second, human capital: the productive wealth embodied in our labour, skills and knowledge, and in an individual's health.

Third, environmental capital: our natural resources and the ecosystems, which include water, productive soil, forest cover, the atmosphere, minerals, ores and fossil fuels.

Fourth, social capital: which includes factors such as the openness and competitiveness of the economy, institutional arrangements, secure property rights, honesty, interpersonal networks and the sense of community, as well as individual rights and freedoms.

Running down the stock of capital in aggregate diminishes the opportunities for future generations, Parkinson says. In one way or another, eroding the productive base will lead to lower future well-being. ''Note, though,'' he adds, ''that drawing down any one part of the capital base may be reasonable as long as the economy's aggregate productive base is not eroded.

''For example, reducing our natural resource base and using the proceeds to build human capital or infrastructure may offer prospects of higher future well-being.

''A necessary, but not sufficient, condition for this to be the case is that those resources are priced appropriately and that the returns are invested sensibly.''

When you think about well-being rather than gross domestic product, he says, it quickly becomes apparent that society doesn't get an adequate return on many environmental goods. For example, water and carbon are not yet priced appropriately.

In the case of minerals and energy, arguably society is not sharing sufficiently in the returns from their exploitation, with the vast bulk of the benefits accruing to the shareholders of the firms doing the mining. As such, society is not getting the resources it would need to build up other parts of its capital stock.

''Unsustainable growth cannot continue indefinitely - if we reduce the aggregate capital stock in the long run, future generations will be made worse off. The problem is that we can be on an unsustainable path for a long period - and by the time we recognise and change, it could be too late.''

Our economy faces a number of pressures on environmental sustainability, including: climate change, salinity and resource depletion, in addition to water availability and pressures on biodiversity. Climate change policy - both in relation to reducing emissions and adapting to climate changes - is not just an environmental issue, Parkinson says. ''It is more fundamentally an economic and social challenge.''

The impact of decisions today will be felt in decades to come, and the progression of climate change impacts is unlikely to be linear (occurring at a steady rate of change). ''There are significant risks and uncertainties arising from our imperfect knowledge of the climate system. It is possible that climate impacts could suddenly accelerate. In fact, certain impacts to the climate system may lead to a tipping point where sudden, irreversible changes arise.''

Parkinson says Treasury, to do its job, needs ''an understanding of well-being that recognises that well-being is broader than just GDP, that sustainability is more than an environmental issue''.

''A focus on well-being and sustainability continue to be important parts of Treasury's culture and identity: they assist in providing context and high level direction for our policy advice; and they facilitate internal and external engagement and communication.

''Almost a decade ago we attempted to put more structure around the issue by writing down a well-being framework to provide greater guidance to staff on our mission.'' The framework is based on five dimensions.

First, the set of opportunities available to people. This includes not only the level of goods and services that can be consumed, but good health and environmental amenity, leisure and intangibles such as personal and social activities, community participation and political rights and freedoms.

Second, the distribution of those opportunities across the Australian people. In particular, that all Australians have the opportunity to lead a fulfilling life and participate meaningfully in society.

Third, the sustainability of those opportunities available over time. In particular, consideration of whether the aforementioned productive capital base needed to generate opportunities is maintained or enhanced for current and future generations.

Fourth, the overall level and allocation of risk borne by individuals and the community. This includes a concern for the ability, and inability, of individuals to manage the level and nature of the risks they face.

Fifth, the complexity of the choices facing individuals and the community. Treasury's concerns include the costs of dealing with unwanted complexity, the transparency of government and the ability of individuals and the community to make choices and trade-offs that better match their preferences.

These five dimensions ''reinforce our convictions that trade-offs matter deeply - trade-offs both between and within dimensions'', Parkinson says.

Well, that's what he thinks.

What do I think? I think Treasury has come a long way and is at its point of greatest enlightenment. But it has further to go - in principle as well as in practice.

In particular, I doubt how much trading off is possible when it comes to the environment.

Ensuring our kids are richer than we are, while destroying the natural environment because we refuse to accept the physical limits to economic growth, doesn't sound sustainable to me.

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Our future is mining, not making

The lessons from BlueScope Steel's decision to sack 1000 workers in Port Kembla and Western Port are that, in the economy, benefits always come with costs: we can't have everything and one country can't do everything well.

Leaving aside the continuing fallout from the global financial crisis, the most momentous, long-term development in the global economy is the rapid industrialisation and urbanisation of the developing countries, with Asia as the epicentre of this trend.

For the economic emergence of the developing countries to be occurring at a time when the major advanced economies of the North Atlantic have made such a hash of their affairs is a great blessing to all of us. Whereas we're used to America and Europe providing the motivating force to the world economy, now it's the strong growth in the developing countries that will keep the world growing.

Among the developed economies, Australia is almost uniquely placed to benefit from the emergence of the poor countries. That's because we're located so close to the epicentre, but also because the main thing we sell the world is raw materials, and raw materials are the main thing the developing countries need to import: energy, food and fibre and, above all, the chief ingredients of steel - iron ore and coking coal.

The world prices of all these things have shot up in recent years and all Australians - not just the miners and farmers - have benefited from them. Although these prices are sure to fall back soon enough, they're still likely to stay much higher than they were. That's because the process of economic development in Asia has so much further to run. As people in poor countries get richer and seek more protein, agricultural prices will probably go a lot higher.

But as well as higher prices, our resources boom has entered a second phase of massive investment in expanding our capacity to supply coal, iron ore and natural gas to the rest of the world. This hugely increased investment spending is set to run for years. It will underpin our economy, protecting us against recession.

That's the good news and, overwhelmingly, this is a good-news story - even though, remarkably, we seem to be in the process of convincing ourselves times are tough and that no one who's not a miner has benefited from the boom: we didn't really have eight income tax cuts in a row; the NSW and Victorian governments aren't really getting bigger shares of the revenue from the goods and services tax at the expense of Queensland and Western Australia; none of us has benefited from the high dollar; we're not taking more overseas trips; not buying cheaper electronic gear and not paying less than we would have for our petrol.

And now, just while we're feeling so uncertain and sorry for ourselves in our immense good fortune, we're reminded that with all the benefits of the resources boom also come costs. Who'd have thought it? Quick, double the gloom.

For decades we thought we were losers, being a country obliged by its history and natural endowment to earn most of its export income from raw materials. Now we discover we're winners. But world trade works by each country specialising in what it's good at. You can't specialise in everything and the truth is we've never been good at manufacturing.

Our domestic market has been too small to give us economies of scale and we've been too far away from

the developed countries that buy manufactures.

The flipside of our increasing specialisation in the export of raw materials is our Asian trading partners' increasing specialisation in what they're best at: using their abundant but mainly unskilled and thus cheap labour to produce manufactures, including steel.

Increasing their exports of manufactures is the way they pay for our raw material exports to them, including the chief ingredients of steel.

Our manufacturers are copping it two ways: increased competition with the growing supply of cheaper manufactures from the developing countries, and our high dollar, which makes our manufacturers' prices high relative to those of other countries' manufacturers.

There are limits to the resources of labour and capital available to us in Australia, so the expansion of mining will tend to pull resources away from other Australian industries, particularly those we're not relatively good at, such as manufacturing. Our high exchange rate - which always rises when commodity prices are high - is part of the market mechanism that helps shift workers and capital around the economy.

There are bound to be a lot more job losses in manufacturing. And a lot of those displaced workers are likely to end up in mining or mining construction. Some, of course, will take the places of other workers who've been attracted into high-paying mining and construction jobs. Others will fill vacancies that have no obvious links to the resources boom.

It will be tough for those workers obliged to make this transition and even tougher for those who don't make it. Fortunately, it's happening at a time when unemployment is low. Even so, governments

need to do all they can to help displaced manufacturing workers find jobs elsewhere.

What governments shouldn't do is increase protection and other assistance to manufacturing industry itself in an attempt to stave off change. It needs to adjust to the reality of a significantly changed world economy.

Efforts to help manufacturing resist change can come only at the expense of all other industries. There are no free lunches in industry assistance.

It would be a good way to fritter away the proceeds from what the governor of the Reserve Bank has called "potentially the biggest gift the global economy has handed Australia since the gold rush of the 1850s".

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Is economic reform worsening productivity?

The North Atlantic economies have pressing problems to grapple with, but here at home the biggest thing we have to worry about is our weak rate of productivity improvement. And we won't get far if we stick to the received wisdom it's all the fault of excessive government intervention.

If our econocrats want to preserve their monopoly over the advice their political masters seek, they need to be less model-bound in their thinking. Since it doesn't take much thought to realise ''more micro reform'' is unlikely to make a big difference, we need more lateral thinking.

Rather than merely assuming market failure wouldn't be a material part of the problem - or assuming nothing could be done to correct market failure that wouldn't make things worse rather than better - perhaps we should look harder to see if market failure is part of the story.

After all, it's the market that's failing to generate as much productivity improvement as it has in the past.

Then we could start looking for cleverer forms of intervention that don't end up being counterproductive. Here we could put a lot more effort into evaluating interventions, so as to build up our understanding of what works and what doesn't.

The acute government debt problems in the United States and Europe are a reminder of how much more fiscally disciplined our governments have been, going right back to the Hawke-Keating government with its various budget limits and targets.

It's a great temptation to give the public the ever-increasing government spending it demands, but then fail to summon the courage to make people pay the extra taxation needed to cover that higher spending.

For all their failings, however, our politicians have achieved balanced budgets on average over the cycle and have kept government debt levels - federal and state - quite low and manageable.

But could it be we've paid for our fiscal responsibility with lower productivity improvement? It seems clear we've been underspending on public infrastructure as part of our efforts to keep debt levels low, but adequate public infrastructure is needed to permit the private sector to raise its own productivity.

As well as physical capital there's human capital. As part of our abstemiousness, we've gone for several decades underspending on all levels of education and training: early childhood development, schools, vocational training and universities. Particularly universities.

If we've gone for so long underspending on human capital, is it any wonder our productivity performance has worsened? It's true the Rudd-Gillard government has loosened the purse strings in recent years, but there's safe to be a delay before that leads to an improvement.

Another possibility worth exploring is whether the microeconomic reforms of the past have had unintended consequences that damaged our productivity.

Micro reform is almost always aimed at increasing firms' efficiency by subjecting them to great competitive pressure - whether from rivals in the domestic market or from imports.

But the human animal has achieved the great things it has not only as a result of competition between us but also as a result of our heightened ability to co-operate in the achievement of common objectives. The economists' conventional model is big on competition, but sets little store by co-operation, since it assumes we're all rugged individualists. Could it be that, by greatly increasing the competition most firms face in their markets, micro reform has reduced the amount of productivity enhancing co-operation?

A further possibility is that, in turning up the heat of competition in so many markets, and in spreading market forces into areas formerly outside the market, micro reform has diminished our ''social capital'' in ways that adversely affect economic performance.

There's no place for trust, feelings of reciprocity or norms of socially acceptable behaviour in the economists' model, so they tend to under-recognise their importance. But you only have to observe a loss of trust within the community to realise the high cost that loss imposes on the economy as well as society.

The less we feel we can trust each other, the more avoidable costs we impose on the economy in spending on supervision and monitoring, security devices and security people.

Micro reform seeks to increase the community's income without paying any attention to the equitable distribution of that extra income. If higher earners end up with more than their fair share, the disaffection of those who lose out may detract from their productivity.

It seems clear the increased competitive pressure on firms has led many to take a more ruthless attitude towards their employees.

Firms are more anti-collective bargaining, more prone to laying off staff as soon as business turns down, more willing to award huge pay rises to executives without a thought as to how this might make other employees feel, more inclined to pay some workers more than their peers, more inclined to expect people to work split shifts or on weekends and public holidays without extra pay and more likely to demand unpaid overtime (which last does increase measured productivity, however).

Is it so hard to credit that all this might have made workers less co-operative and productive rather than more?

In the Treasury Secretary's recent speech on our poor productivity performance, Dr Martin Parkinson nominated health and education as the next candidates for major micro reform. He's right, there's plenty of scope for improvement.

But these are service-delivery sectors where it's the performance of professionals that's crucial. And economists' notions about what motivates people and how you encourage excellence are so blinkered - they assume money is the only incentive and key performance indicators work a treat - that you'd have little confidence their ''reforms'' would make things better.

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The real action is in the developing world

If the US, the world's biggest economy, starts to contract again and the Europeans' government debt problems prompt more austerity, the world economy will be plunged back into recession. Is that what you think? If so, your picture of the world economy is about 20 years out of date.

There are cultural, historical, family and language reasons why we focus our attention on Europe and the US. The media keeps us well informed about what's happening in their economies. And since, between them, they account for a big chunk of the world economy, it's easy to assume that where they go the rest of the world follows.

Indeed, that used to be true. When I first got into this game, the Organisation for Economic Co-operation and Development used to make forecasts for its 24 rich-member countries, add them up and call it the world economy.

But consider these figures from the Reserve Bank's latest statement on monetary policy. Over the four-and-a-bit years since the March quarter of 2007, the world economy has grown by about 10 per cent in real terms.

The contribution of the North Atlantic economies (the US, Canada, Britain and the euro area) to that growth was near enough to zero. So all the net growth the world's seen in that time has come from the remaining, mainly developing, economies.

Between them, the Chinese and Indian economies have grown by nearly 50 per cent, while east Asia (excluding China and Japan) grew by almost 20 per cent.

The faster the developing countries grow relative to the rich countries, the larger their share of the world economy becomes. An article in The Economist points to the many respects in which the world economy is coming to be dominated by the "emerging economies", as they're increasingly called.

As many as 11 of these economies have emerged to the point where they've been reclassified as developed rather than developing. But when you do that, you understate the extent to which the developing countries are taking over the running. So the figures that follow classify as developing all those countries that hadn't made it to developed status before 1997.

The developed countries account for only about 15 per cent of the world's population, but in 1990 they accounted for 80 per cent of gross world product. By last year that share had dropped to 60 per cent. It is projected to fall to less than half within the next seven years.

But that calculation is based on converting each country's gross domestic product into US dollars at market rates. This understates the developing countries' share of gross world product (GDP) because one US dollar buys a lot more in poor countries than in rich countries.

When you adjust for "purchasing-power parity" you find the developing countries' share of gross world product reached 50 per cent three years ago and is expected to reach 54 per cent this year. Their share of world exports has reached half, which is almost double what it was in 1990.

Much of these exports would be produced by multinational companies operating in developing countries, so it's no surprise the developing countries attract more than half of all the inflows of foreign direct investment.

So far, this conforms to the popular perception of developing countries as economies that make their living selling cheap exports to rich countries. But The Economist observes that "foreign firms are increasingly lured by these countries' fast-growing domestic markets as much as [by] lower wages".

That's the point: developing countries are increasingly standing on their own feet, generating their growth internally.

The mainstays of "domestic demand" are capital (investment) spending and consumer spending. The developing countries now account for more than half the world's capital spending, compared with a quarter 10 years ago.

Last year the US's capital spending was just 16 per cent of its GDP compared with 49 per cent in China. (Ours was 28 per cent.)

The developing countries' share of world consumer spending is only 34 per cent, though this is up from 24 per cent 10 years ago (and would be higher if you allowed for the lower prices they pay for housing and services).

Even so, their shares are: 46 per cent of world retail sales; 52 per cent of all new car sales (up from 22 per cent in 2000) and 82 per cent of all mobile phone subscriptions.

You can see from this how rapidly living standards are rising in poor countries. And when the locals start spending, some of that spending is on imports. Last year the developing countries' share of world imports rose to 47 per cent.

So whereas we're accustomed to thinking of developing countries as dependent on rich countries, it's becoming more the case that the rich countries depend on the developing countries.

Even so, because the developing countries are still at the early stages of developing their economies, their demand for basic commodities - whether locally produced or imported - exceeds their demand for sophisticated goods and services.

They account for 60 per cent of the world's annual energy consumption, 65 per cent of all copper consumption and 75 per cent of all steel use. Yet, as The Economist remarks, there's plenty of room for growth: they use 55 per cent of the world's oil but their consumption per person is still less than a fifth of that in the rich world. (Always assuming we don't run out of oil, of course.)

And here's a pertinent reason the developing countries are likely to continue growing faster than the North Atlantic economies: they're responsible for only 17 per cent of the world's government debt.

No prize for having guessed the punchline: the rich countries likely to do best over the rest of this troubled decade are those most closely plugged into the developing world.

Heard of a poor, cautious, sorry-for-itself country called Australia? It sells less than 10 per cent of its exports to Europe and only 5 per cent to the US, but about two-thirds to developing countries.

Most of those countries are in Asia, of course, the most dynamic part of the world economy. In just the past 10 years, China's share of our exports of goods and services has gone from 5 per cent to 23 per cent, and India's has risen from 2 per cent to 7 per cent.

As Wayne Swan keeps saying, Australia is in the right place at the right time.

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Sorry to be so sober. World not ending

At times like these, much of the media tends to cater to people who enjoy a good panic. The sky is falling and the proof is that billions have been wiped off the value of shares in just the past few days. Which makes me wonder how I've survived in the media for so many years. I hate panicking. So I'm always looking for contrary evidence. I just have hope there's a niche market of readers who prefer a sober assessment.

A bane of my working life is the way people imagine the state of the sharemarket to be far more important than it is in the workings of the economy. Our response to big falls in the sharemarket is based more on superstition than logical analysis, and a lot of people who should know better are happy to pander to the public's incomprehension.

We have a kind of race memory - a relic from the 1930s - that tells us a sharemarket crash is invariably followed by an economic slump. It ain't. As the Nobel-prize winning economist Paul Samuelson once quipped, ''the stockmarket has predicted nine of the past five recessions''.

Do you remember the crash of October 1987? No, probably not. There's no great reason to. It was the biggest fall on Wall Street since the Great Crash of 1929. People were panicking on that day in 1987 much as they are now.

A commentator senior to me predicted on page 1 it would lead to a global depression. In my comment - which was relegated to an inside page - I predicted no worse than a world recession. Fortunately, my thoughts were billed as ''The End Is Not Nigh''.

Turned out we were both way too pessimistic. What transpired? Precisely nothing. Neither in America nor here. In Australia the economy motored on for more than another two years before a combination of the subsequent commercial property boom and many more increases in the official interest rate finally brought us the recession we had to have.

The trouble with taking the sharemarket as your infallible guide to the economy's future is that the market itself is prone to panic. As its practitioners admit, its mood swings between greed and fear. Like all financial markets - and like the media - it acts in haste and repents at leisure. You can panic today because you can always change your mind tomorrow.

That's fine when onlookers don't take the market's antics too seriously. When they take its mood swings as authoritative, however, their reactions can cause those antics to have adverse effects on the ''real'' economy of spending and jobs that we inhabit.

In other words, what's important is not the ups and downs of the sharemarket, but the way we react to them.

In 1987, a lot of ordinary people who'd bought shares during the boom rushed out and sold them - thus buying high and selling low, precisely the opposite behaviour to the way you make money from shares. But the public soon shrugged off its anxiety and it wasn't long before the market recovered its lost ground.

Of course, a lot of things have changed since that great non-event of 1987. In those days, the link between the sharemarket and our daily lives was quite tenuous. These days, the link is much stronger thanks to the advent of compulsory superannuation - which has given most of us a fair stake in the sharemarket - and the baby boomers' proximity to retirement.

These days a sustained fall in share prices knocks a noticeable hole in people's retirement savings. That hole will refill in time, but who's to say how long it will take? Another difference with 1987 is that, this time, the sharemarkets in Wall Street and Europe really do have things worth worrying about. The American economy is quite weak and, although it's unlikely to drop back into recession unless Americans will it to, it's likely to stay pretty weak for the rest of the decade.

It's the Europeans who have by far the most to worry about, with so many heavily indebted governments locked into the euro and banks that are still in bad shape.

But yet another thing that's changed since 1987 is our economy's reorientation away from America and Europe towards China and the rest of Asia. Much of the fear that rises in our breasts on hearing of crashing sharemarkets is our unthinking conviction that what's bad for them must be bad for us.

It ain't so - not unless we unwittingly make it so. There never was a time when our economy was less dependent on the US and Europe than it is today. Well over half our exports go to Asia, with surprisingly small proportions going to the US and Europe.

It's true we're quite heavily dependent on China, but its problems are all in the opposite direction to those of the North Atlantic economies: it's growing too strongly and could use a bit of a slowdown. There never was a time when China was less dependent on the US and Europe than it is today. The notion that the world's second-largest economy lives or dies by its exports to the North Atlantic is silly.

But if all this is true, why does our sharemarket still take its lead from Wall Street? Because of its tendency to herd behaviour. By tacit agreement, what Wall Street's done overnight acts as a signal to all Australian players of the direction in which our market will be travelling.

What holds in the short term, however, shouldn't hold forever. Eventually, the price of a BHP Billiton share will reflect the profit-making prospects of BHP - and they're still very good.

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