Monday, May 21, 2012

How spin doctors have taken control of budget papers

What if I told you the true expected budget balance for next financial year wasn't the much trumpeted surplus of $1.5 billion but a carefully buried deficit of $8.7 billion?

I'd be justified in making such a statement because that deficit figure is officially known as the "headline cash balance" and, as a journalist, I'm in the headline business.

I'd also be justified in drawing it to your attention because the government in its budget papers has made no effort to convince us the headline figure is of no macro-economic significance - rather, we should focus solely on the "underlying cash balance" of a $1.5 billion surplus.

Indeed, I'm not sure the headline figure is of no macro significance. Why not? Because I happen to know - no thanks to the government - that the difference between the two figures includes, among various things, the government's spending on the rollout of the national broadband network.

That's of no macro-economic significance? That has no effect on economic activity? Don't think so, chaps.

I'd really like to be able to tell you just what the transactions are that explain the difference between the headline and the underlying balances. But if there's a table anywhere in the voluminous budget papers spelling that out, I can't find it.

I'm sure if the econocrats had their way there'd be such a table, but the preference of the politicians and their private-office spin doctors is to conceal rather than explain. And even just the figure for the ironically titled headline balance has been carefully hidden to ensure it doesn't hit the headlines.

It didn't rate a mention in the Treasurer's budget speech; in the multicoloured Budget Overview document it was included as a "memo item" (that is, they don't tell you how it was arrived at) on page 36.

In the budget papers proper, it went unmentioned in budget statement 1 (also known as the budget overview) and got a single mention on page 9 of budget statement 3.

The hiding of the headline deficit is just one example of the way the budget papers are becoming less informative rather than more, and the way the government's spin doctors are turning them into an exercise in media management rather than transparency and accountability.

The budget speech used to be a thorough and trustworthy exposition of the new measures announced in the budget; these days it's a made-for-television rave about the budget's good points.

I suspect one reason the budget papers have become less rather than more user-friendly over the years is the spin doctors' desire to drive journalists away from the budget papers proper to the multicoloured Budget Overview, known to econocrats as "the glossy".

It's glossy by name and gloss by nature, putting the best gloss possible on the budget and focusing on whatever messages the government is trying to peddle.

It offers a seemingly useful list of the "major savings" announced in the budget, but you can't be sure all the "saves" you'd like to know about are listed. The single line for "other" savings accounts for almost a quarter of the total.

But that's honest compared with the list of "major initiatives" announced in the budget, otherwise known as "spends". It's a table without totals, meaning it doesn't even have a line for "other" spending. If it did, other would account for almost a third of the total.

Spin doctors work on the assumption journalists are both dumb and lazy, meaning they'll focus on whatever news you give them and not think to go looking for the things you conceal. They also assume journalists who benefit from background briefings and selective leaks won't be game to complain publicly about the way they're led around by the nose.

Journalists turn a blind eye to the rank hypocrisy of the Treasurer and Finance Minister piously refusing to comment on what may or may not be in the budget, while the Prime Minister's press office leaks much of its content to selected journalists, then quietly confirms the story's accuracy to those journos who missed the exclusive.

Unfortunately, there are head office-based journos who aren't part of the club and so feel no such inhibition. There are also, believe it or not, economists and even the odd private citizen who read the budget papers in the hope of enlightenment. They're getting the bum's rush.

This year AAP has accused the government of leaking budget information to selected media for broadcast during the budget lock-up. How's that for duplicity.

Budget paper No 1's coverage of revenue items is pretty thorough, but its statement on expenses leaves much to be desired. It's been stripped of its former graphs showing how spending categories have grown over the years and its tables showing the figures for major spending categories over many years. This paper used to have an index to help you follow a query through, but that was dropped long ago.

You have to delve as far as budget paper No 2 for reliable explanations of particular budget measures, but this information is listed by department rather than program or function, and little effort is made to help users find what they're looking for.

Federal bureaucrats are convinced they're superior to state bureaucrats in all respects, but the states' budget papers are generally superior to the feds' in their transparency, rigour and comprehensiveness. Federal budget papers are particularly inadequate on information about non-financial corporations, such as the NBN Co Ltd.

So tight is the spin doctors' hold on the federal budget process that some nameless operative in the "media liaison" section of the "communications unit" within Treasury's "ministerial and communications division" summarily declined, without explanation, a newspaper's request for budget tables to be supplied in spreadsheet format.

Saturday, May 19, 2012

Macro 'policy mix' returns to normal

In case you missed it, the secretary to the Treasury has spelt it out: with the budget's planned return to surplus next financial year, fiscal policy is being put back in the cupboard and the "policy mix" returned to normal.

Delivering his annual post-budget speech to the Australian Business Economists, Martin Parkinson outlined the "macro-economic framework" - the respective roles of fiscal policy (the manipulation of government spending and taxation), monetary policy (the manipulation of interest rates by the Reserve Bank) and the exchange rate.

"The primary responsibility for managing demand to keep the economy on a stable growth path consistent with low inflation" had been allocated to monetary policy, he said.

So "normal" is for monetary policy to be doing most of the work in keeping the economy steady. Its aim is "to maintain inflation between 2 and 3 per cent, on average, over the cycle". But, as you see, this doesn't mean the Reserve focuses on inflation to the exclusion of all else.

While keeping inflation low may be the target, the goal is non-inflationary growth - growth which should keep unemployment low.

And a key part of the mechanism for achieving low inflation and steady, job-creating growth is, in Dr Parkinson's words, "anchoring inflation expectations". Because the expectations of wage negotiators and businesses tend to influence the demands they make and the prices they set, keeping them expecting inflation to remain low is half the battle.

That's one of the main roles of the inflation target. Provided people are confident the Reserve will stick to its target - as they are - you can allow the economy to grow at a faster rate than otherwise.

Parkinson linked monetary policy with the exchange rate. "Monetary policy is supported by a floating exchange rate, which acts as a shock absorber that offsets some of the effects of global shocks on the economy and naturally adjusts in response to other economic developments," he said.

When, for instance, world commodity prices rise a lot and our terms of trade improve, the dollar tends to rise.

The extra national income flowing from the higher export prices would lead to a surge in demand that could be inflationary (and, in the days when our exchange rate was fixed, it was). But the higher exchange rate reduces the international price competitiveness of our export and import-competing industries which, by reducing exports and increasing imports, reduces the external component of aggregate demand (gross domestic product).

And this, combined with the direct reduction in the prices of imports, helps keep inflation under control. The exchange rate has thus absorbed some of the shock from the rise in commodity prices and so kept the economy growing steadily. When commodity prices fall, the process works in reverse.

But if monetary policy is the main policy instrument used to keep the economy on an even keel, what is fiscal policy's role?

Parkinson says a key objective of fiscal policy is "to maintain fiscal stability from a medium-term perspective". That is, to ensure we don't run so many budget deficits that, in time, we build up a level of government debt that becomes unsustainable.

(To see what nasty things can happen when you don't "maintain fiscal stability" look no further than Greece, with Italy and other European economies heading down the same track.)

But this is Parko's key message: "Outside of the automatic stabilisers, discretionary fiscal policy should only be used for supporting demand during extreme circumstances, such as when: the effectiveness of monetary policy is impeded; and/or a shock is sufficiently large and sufficiently sudden that monetary and fiscal policy should work together to support activity, such as during the global financial crisis."

Let's unpack that mouthful. As we saw here last weekend, the budget contains "automatic stabilisers" that cause the budget balance to deteriorate when the economy turns down and improve when the economy turns up.

So the budget acts automatically to help stabilise the economy as it moves through the business cycle, with public sector demand expanding automatically at times when private sector demand is weak, and contracting automatically when private demand is strong.

Parkinson is saying this is a good thing and the macro framework requires that the automatic stabilisers be unimpeded in doing their job. That is, governments shouldn't take explicit ("discretionary") decisions that counter the effect of the stabilisers.

(Attempting to counter the stabilisers is exactly what the Brits and other Europeans are doing with their "austerity" policies. They've been slashing government spending at a time when the economy is weak. This weakens demand further, pushing the economy back into recession and, far from reducing the budget deficit, makes it worse. By ignoring elementary Keynesian principles, they've blundered into an adverse feedback loop.)

The next element in Parkinson's exposition of fiscal policy's role in the macro framework is that governments may take discretionary measures that reinforce the effect of the stabilisers, but only in extreme circumstances - such as a potentially serious recession.

In other words, apart from allowing the stabilisers to do their thing, it's not normal practice for fiscal policy to be used to manage the strength of demand from year to year. That's the job of monetary policy, for which it's better suited (because it can be adjusted quickly and easily and in small or large steps).

Parkinson says we've had such a "medium-term" approach to fiscal policy since the mid-1980s, "before evolving into a fully articulated framework with the development of [Peter Costello's] Charter of Budget Honesty in the second half of [the] 1980s". The charter requires the government of the day to announce a "medium-term fiscal strategy" and Wayne Swan's strategy is only marginally different from Costello's: "to achieve budget surplus, on average, over the medium term".

This formulation is carefully designed (by, I suspect, the Liberals' Senator Arthur Sinodinos) to allow the automatic stabilisers to push the budget into deficit during recessions - and even to permit governments to implement fiscal stimulus packages during recessions, as this government did - provided the stabilisers are unimpeded in returning the budget to surplus and any stimulus spending is ended.

This means that, over time, all the deficits incurred during downturns are roughly offset by all the surpluses achieved during upswings. The surpluses are used to pay off the deficits, thus keeping the level of government debt steady and sustainable over time.

So fiscal policy and monetary policy have different roles, and monetary policy and discretionary fiscal policy need to pull together only in emergencies.

Wednesday, May 16, 2012

Why a little more redistribution is justified

So, has the budget led to an outbreak of class warfare? Only if Julia Gillard's a lot luckier than she's been so far. That is, I doubt it. What I don't doubt is that her disparaging remark about the north shore was a calculated attempt to get a bit of class consciousness going to accompany her give-and-take budget.

But loyalty to parties on the basis of class is long gone. These days people's vote is as likely to be guided by the party divide on social issues as economic ones. Then there's the rise of the "aspirational" voter - people who don't mind seeing the better-off favoured by the government because they hope to be better off themselves one day.

If the public's reaction to this budget is any guide, we've either all become aspirationals or, more likely, a lot of people don't know which side their bread's buttered on. Wayne Swan brings down a Robin Hood budget and, according to last week's Herald poll, 43 per cent of respondents think it will leave them personally worse off and only 27 per cent expect to be better off. Talk about living in a fog.

Be in no doubt: this budget is the most highly redistributive in years. Whether out of desire to awaken class loyalties, to soften the blow of the carbon tax, or to buy votes, this budget gives quite a bit of money to low- and middle-income families.

The discretionary increase in the means-tested family benefit, to take effect from July next year, is well targeted to families in greater need.

The schoolchildren's bonus, the first payment of which will be made within a few weeks, goes only to parents eligible for the family benefit. It's a big improvement on the education tax refund, which mainly benefited those parents able to spend big on eligible equipment and savvy enough to keep receipts and make the claim.

The new income-support supplement, to take effect next March, will give people on the dole a princely 57? a week extra, reducing by a sliver the extent to which we require them to subsist below the poverty line. It is, nevertheless, the first real increase to the dole for more than 20 years. The budget plans for increased spending on dental health for the needy and a start to the national disability insurance scheme in July next year.

But though these measures are welcome, they hardly represent the big increase in welfare their critics claim. According to the calculations of Professor Peter Whiteford, of the University of NSW, their cost of $8 billion over four years represents an increase of less than 1 per cent of total budget spending on health and social security.

Helping to pay for these increases are cuts aimed squarely at the better-off. The top 1 per cent of taxpayers, earning more than $300,000 a year, will have the tax break on their superannuation contributions cut from 31.5? in the dollar to 16.5?, putting them on a par with most workers.

The provision allowing workers over 50 to make low-taxed super contributions up to $50,000 a year - that is, to exploit the salary sacrifice rort (as I've been doing) - will be cut to $25,000 from July. Those with super balances under $500,000 were to have been given an exemption from the cut, but this has been deferred for two years, thus largely closing the salary sacrifice loophole.

Despite the hard-luck stories, workers not on high incomes can't afford to sacrifice salary in this way.

The capped 50 per cent discount on the tax on interest income, which now won't happen, would have benefited the better off, as does the tax offset on net medical expenses, which is to be virtually eliminated.

Almost everyone - whether on the right or the left - automatically assumes company tax is a tax on the rich. So those excitable souls claiming the budget was a plan to "smash the rich" list as Exhibit A the decision not to cut the rate of company tax by 1 percentage point, as had been promised.

But Australian shareholders - including Australian super funds - get tax credits for the company tax paid on their behalf. And tax economists argue that, in the end, the burden of company tax is borne mainly by wage-earners.

So it's not at all clear to me that company tax is a tax on business or on the rich. Business was never terribly enthusiastic about the 1 per cent cut; I'm unimpressed by the bitter tears it's shedding now.

When you combine this Robin Hood budget with the way the tax cuts linked to the carbon tax are limited to individuals earning less than $80,000, with the way the temporary flood levy was aimed at the better off, with the various previous measures to reduce upper-middle class welfare and with the 2009 discretionary increase in the age pension (the largest real increase in the pension ever), you do have to conclude this Labor government, particularly under Julia Gillard, is very redistributive - though its record isn't unblemished.

And unless you're happy to see the gap between rich and poor widening - as it has been - that redistribution is not unwarranted.

According to figures from the Bureau of Statistics, between 2003-04 and 2009-10, average household disposable income rose by 26 per cent in real terms.

But the income of the bottom fifth of households rose by 17 per cent, whereas the income of the top fifth rose by 32 per cent.

Remember that next time you hear highly paid business people banging on about the budget being "more about how we carve the pie, rather than how we grow the pie". It was about time.

Monday, May 14, 2012

Swan's innovation: the budget as bulldozer

A closer look at the budget papers reveals just how contrived the budget's return to surplus is. Wayne Swan is hardly the first treasurer to resort to "reprofiling" (a word his people invented), but he's the first to use it on such a massive scale, turning the budget into a bulldozer.

Reprofiling means changing the previously announced timing of budget spending or taxation measures. Deciding not to proceed with previously promised tax changes (the 1 percentage point cut in the company tax rate, the standard deduction, the limited 50 per cent discount of tax on interest income) is one thing. In contrast, deciding to defer by two years the increase in the cap on super contributions by older workers is an example of reprofiling.

Nothing demonstrates how contrived this budget is better than the expected real growth in government spending. In the financial year just finishing, 2011-12, spending is expected to have grown by a whopping 4.8 per cent. In the budget year, 2012-13, it's budgeted to fall by a whopping 4.3 per cent.

But the following year it resumes its rapid upward climb, growing by 3.7 per cent. The year after, up by a modest (!) 2 per cent, and in the last year of the forward estimates, 2015-16, up by 2.9 per cent.

The budget papers helpfully note that, if you roll together the old year and the budget year, the average rate of growth is just 0.3 per cent. This tells us, first, much of the real fall in spending in the budget year is achieved by the simple expedient of pushing spending back into the old year.

Second, to have real spending growing for two years in a row at an infinitesimal rate is quite unnatural. And since there have been no announcements of swingeing spending cuts, such a situation could only have been contrived.

In fact, Swan was moving the budgetary furniture around in at least the two previous budgets (and last November's midyear budget review) to make ready for the miraculous return to surplus in 2012-13.

But so extensive have been his labours to bring the planned surplus about that a more robust metaphor is called for. Swan has invented the fiscal bulldozer. The Treasurer always has a big pile of spending in his blade that he's pushing forward into later years.

And, because budgets occur in May, the dozer can always be turned around and used to push spending back into the few remaining weeks of the old financial year.

But let's focus on the measures announced last week. Swan announced "saves" worth $33.6 billion over five years (the old year, the budget year and the three "forward estimate" years) less "spends" worth $22.4 billion over five years. So for every $3 he saved, he gave away $2.

Note, however, that half his saves were tax measures rather than cuts in spending. Of the total value of tax saves, only 40 per cent represents actual tax increases, while 60 per cent represents decisions to abandon or defer tax reductions included in the mining tax package.

When the package was first announced, pretty much all the revenue expected to be raised by the new tax was used to pay for "reforms" of other aspects of the tax system. These alleged reforms were very roughly based on recommendations of the Henry report. But now, roughly $2.2 billion a year of the mining tax's annual proceeds is to be used to finance increased government spending rather than reductions in other taxes.

The budget papers link the changes to the mining tax package to the plans for an increase in the family benefit, the new (pitiful) allowance for people on the dole, the switch from the education tax refund to the "schoolkids bonus", the first stage of the national disability scheme and the increased spending on dental care.

In their efforts to make announcements sound momentous, it suits the pollies and the media to quote budget costs "over four years" (or five, if costs are being pushed back to the old year).

But we budget and think a year at a time, so this practice can mislead.

It's worth noting that, of the total saves of $33.6 billion, only 14 per cent apply to the budget year. This tells us Swan drew up this budget very much with an eye to the following years. Having orchestrated the planned return to surplus in 2012-13, he then had to make sure the budget stayed in surplus over the forward estimates.

Of his total spends of $22.4 billion, a mere 8 per cent apply to the budget year. This is another indicator of how contrived the budget is.

But it also helps explain how a supposedly tight budget could appear so generous, as well as revealing another modern trick: pre-announcement.

Rod Tiffen, of the University of Sydney, has beaten the economic commentators to making a significant point - increasingly, budgets are being used to announce measures that don't take effect for more than a year. Budget headlines are built on stuff that won't happen for ages.

In the case of new taxes, such delay is unavoidable. But that's rarely true of spending. Among the measures announced last week that don't start until July 2013 are the increase in the family benefit and the introduction of the national disability scheme. The dole increase doesn't start until March 2013.

Combine all this with the knowledge the government has never once honoured its grand pledge to increase defence spending each year by 3 per cent in real terms and you conclude Swan's fiscal bulldozer will be on the job again in next year's budget - and any to be delivered by his successors.

Environmental accounting: completing the picture

Dinner Talk to ABS Conference on Environmental Accounting, Melbourne, Thursday, May 14, 2012

Ross Gittins, Economics Editor, The Sydney Morning Herald

I’m pleased to be invited to speak to this dinner of a conference convened by the nation’s official bean-counters. I don’t use that term disparagingly. Some people may think they’re far too talented or too important to waste time counting the beans, but I’m not one of them. If outputs and outcomes are important, then measuring them must be too. I’ve had two careers so far, and both have involved bean-counting. The first was as a chartered accountant, and the accountant in me meant that when I switched to economic journalism, I devoted considerable time to making sure I understood how the key indicators of the economy’s health ticked - the labour force survey, the CPI, the balance of payments, the national accounts and so on. I agree with the quote from the Stiglitz-Sen commission, which could almost be the public statisticians’ mission statement: ‘What we measure affects what we do; and if our measurements are flawed, decisions may be distorted’.

I’m also pleased to be speaking at a conference devoted to a subject so close to my heart: how we can establish a system of environmental accounts capable of being integrated with the economic accounts, to eventually produce a bottom-line figure for ‘green GDP’. It may be a sign of old age, but as the years have gone by I’ve become increasingly concerned about the interrelationship between the market economy - as we define it and measure it - and the natural environment - the ecosystem - in which it sits and on which it depends for its continued survival.

It’s clear we need to know a lot more about, and take a lot more notice of how the natural environment is changing over time, mainly as a result of human activity. That is, we need to be doing a lot more measuring of the environment, in its own right. We must keep track of what’s happening to be sure we’re not caught out by developments we didn’t quite notice before they became acute.

And, turning to the economy, the way we manage it - and the way we measure it, because measurements inform managers - needs to change over time to keep up with change in the economy and its environment, and also with developments in the scientific understanding of the way economic activity impinges on the social and natural environment in which the economy operates. Economists and statisticians have been slow to recognise the need for change in the way we define and measure ‘the economy’, but now, thankfully, real progress is being made - as witness the SEEA (system of environmental and economic accounting) and, indeed, this conference.

When you think about it, however, it’s not surprising that, at the time in the 19th century when our way of conceptualising the economy was being laid down by Alfred Marshall and the other neoclassical economists, it was considered possible to think of ‘the economy’ in splendid isolation from what then, I guess, would have been thought of as Nature, but we today have been schooled by natural scientists to think of as the ecosystem.

A hundred and fifty to 200 years ago, global economic activity was puny compared to the vastness of the global ecosystem - the vast oceans, endless forests, the geographical barriers between continents and countries, the perishingly cold winters and, in faraway climes, the intolerable heat. With humankind so puny and nature so vast as to seem almost infinite, it made all the sense in the world to view ecosystem services and environmental assets - air and water and fish and sunlight - as so infinitely available they could be treated as ‘free goods’, goods that had no price and so didn’t need to be taken into account. There was pollution, of course - factories that made loud noises, belched smoke, emitted waste material into the river and maybe left the hillside scarred - but these things were limited and local. They were unpleasant, but they weren’t something to worry too much about.

Two things have changed since those days. The first is the unbelievable growth in economic activity across the globe. Advances in public health and personal healthcare, and advances in economic production techniques, have seen the world’s population increase by a factor of seven since the dawn of the 19th century from 1 billion to 7 billion today. And advances in production techniques on their own have seen the average material standard of living across the world increase by a factor of six over the same period. Put the two together and economic activity, as measured, has increased by a factor of at least 42. Suddenly, global economic activity isn’t looking so puny and the global ecosystem isn’t looking so vast.

The second thing that’s changed since the industrial revolution is the depth of scientific understanding of the way the natural world works and the effects human activities are having on the way it works. First among these discoveries is the first law of thermodynamics which, for our purposes, tells us that economic activity can’t increase or reduce the quantity of anything, just change its form. So what the economy does from a physicist’s perspective is take natural resources and turn them into various forms of waste. Any system of environmental accounts - and any attempt to integrate environmental and economic accounts - has to take account not only of the natural inputs to the economic system but also the output of waste from the system.
Scientists have also made us aware of the way farming practices have affected river systems and underground water systems, the effects of commercial fishing, the limitations to fish farming, the extent of the destruction of species and, of course, the way the burning of fossil fuels and clearing of forests is changing the climate.

If I didn’t know I wasn’t allowed even to think it, I’d be tempted to say the extraordinary growth in global economic activity relative to the eternally fixed size of the ecosystem must surely be taking us close to the limits to economic growth - at least as we presently define growth and pursue it. Surely that’s precisely what the climate science is telling us. We’ve reached the limit to our ability go on burning fossil fuels and destroying natural carbon sinks in forests and so forth. We’re perilously close to natural tipping points - points from which there can be no return to the way things used to be. When the definition of the problem is limited to climate change, many, probably most, economists are willing to accept that things can’t continue the way they have been. But I can’t believe the environmental problem is limited to climate change; that we don’t face similar major threats to the status quo from farming practices, water and land degradation, overfishing and species destruction. I don’t believe we can go on indefinitely increasing our throughput of natural resources and our interference with the operation of ecosystem services.

This is not to say the end of the world is nigh, or even the end of economic activity. But it may well presage the end of global population growth and that part of economic growth that’s based on growth in the use of natural resources. What we don’t have to give up is the other part of economic growth, which comes from productivity improvement and technological advance. It may well be, however, that the objective of productivity improvement needs to change from economising in the use of labour to economising in the use of natural resources. Markets will always economise in the use of the most expensive resource, which in developed economies is labour. We need to turn that around, partly by ensuring natural resources are properly priced to reflect their true social costs and partly by shifting the tax system away from its present heavy reliance on taxing ‘goods’ such as labour to taxing ‘bads’ such as the use of natural resources.

When scientists talk about the limits to growth, economists always accuse them of failing to understand the ability of the price mechanism to solve or work around the seemingly looming end to the availability of particular natural resources, including the price mechanism’s ability to call forth technological solutions to the problem. To this the scientists always retort that economists are hopelessly unrealistic ‘technological optimists’.

I think the truth’s in the middle. In the economists’ mind, the price mechanism solves problems in a way that’s simple and reasonably smooth. They tend to think in comparative statics - the economy snaps from one equilibrium to another - without giving much thought to the dynamics of the adjustment process and the possibility of path dependency, of being knocked off course before you reach the expected equilibrium. I’m not confident of the ability of global commodity prices to adequately foresee emerging shortages around the corner and thereby send a clear enough, and early enough, signal to innovators to get on with finding their technological solution to the problem. If huge price increases occur with little warning and there’s a delay of some years before technological solutions emerge, considerable economic damage can be done in the interim, with unexpected flow-on effects and less-than-efficient policy responses by governments. And all because of economists’ naive faith that the real world will adjust in textbook fashion.

I was interested to see that highly orthodox institution, The Economist magazine, seriously entertaining the possibility of Peak Oil in a recent article (Buttonwood column, Feeling Peaky, April 21, 2012). It noted that global output of crude oil (as opposed to alternatives such as biofuels and liquids made from gas) has been flat since 2005. You can argue the world is ‘awash with energy’ thanks to the exploitation of American shale gas, but The Economist counters that oil is still the main fuel powering the globe’s fleet of cars and trucks. You could convert them all to liquid gas, but you can’t do it without considerable expense and delay, with the prospect of pretty bad things happening in the interim. You could find more oil - in the Arctic or in tar sands - but you couldn’t do that without a considerable increase in the price of petrol. Remember, too, that some potential alternatives to conventional oil - including biofuels and tar sands - are highly ‘energy inefficient’ - you have to expend a lot of energy to produce them. And the fact remains that, just as the industrial revolution was built on coal, so the post-war economy has been built on cheap oil. If oil and its substitutes are now to be very much more expensive, this spells significant cost, economic disruption, social hardship and weaker growth.

But I’ve provoked you enough with the threatening thought that there may be limits to growth after all. Now I want to view the case for measuring change in the environment - and for combining it with the measurement of the economy - from a different perspective. As you know, the overriding goal of microeconomics is to help the community deal with ‘the problem of scarcity’ - the fact that the physical resources available to us are finite, whereas our wants are infinite. There’s any amount of goods and services we’d like to consume, but the wherewithal to produce those goods and services is strictly limited.

But Avner Offer, a professor of economic history at Oxford, and others have advanced an interesting proposition: that the developed market economies’ attack on the problem of scarcity over the time since the industrial revolution has been so remarkably successful that we’ve actually defeated scarcity and replaced it with a different problem, the problem of abundance. Now, technically, for an economist to say that a resource is scarce is merely to say that it can only be obtained by paying a price, that it’s not so abundantly available as to be free. Clearly, in that technical sense, the problem of scarcity is still with us.

But, in the broader sense, it’s hard to deny that the citizens of the developed world live lives of great abundance. As we’ve seen, our material standard of living has multiplied many times over since the start of the industrial revolution. No one in the developed world is fighting for subsistence; even the relatively poor among us are doing well compared with the poor of Asia or Africa; we satisfied our basic needs for food, clothing and shelter a mighty long time ago; our real incomes grow by a percent or two almost every year, and each year we move a little higher on the hog. Our greater affluence can be seen in our ability to limit the size of our families, in the growth in the size and opulence of our homes, the fancy foreign cars we drive, our clothes, the private schools we send our children to, the restaurants we eat in and the plasma TVs, DVDs, video recorders, personal computers, mobile phones, stereo systems, movie cameras, play stations and myriad other gadgets our homes teem with.

How has this unprecedented and widespread affluence come about? It’s the product of the success of the market system. But above all it’s the product of all the technological advance - the invention and innovation - the capitalist system is so good at encouraging. Malthus’s dismal prediction in the late 1700s that the growth in the population would outrun the growth in food production was soon disproved.
It’s therefore reasonable to say that, when we look around us, what we see is not scarcity but abundance. This is something to be celebrated. But, as with everything in life, no blessing is unalloyed. Every good thing has its drawbacks and difficulties. As we’ve seen, the first and most obvious problem with abundance is the damage the huge expansion in economic activity is doing to the natural environment.

The next but less obvious problem with abundance is that it exacerbates humankind’s difficulty achieving self-control. Notwithstanding the economists’ assumption of rationality, humans have a big problem with self-control. It’s ubiquitous to daily life: the temptations to eat too much, get too little exercise, smoke, drink too much, watch too much television, gamble too much, shop too much, save too little and put too much on your credit card, to work too much at the expense of your family and other relationships.

The more stuff we have - the fewer among us whose main problem remains satisfying our basic needs - the more problems of self-control emerge as our dominant concern. But there’s a deeper point: humans have never been good at self-control, but as long as we were poor and resources were scarce, our self-control problem was held in check. It’s when things become abundant, when we can afford to indulge so many more of our whims, when we have a huge range of things or activities to choose from, that self-control problems become more prevalent and we have trouble making ourselves choose those options that are best for us in the longer term, not just immediately gratifying.

The topical problem of obesity provides an excellent example of the way the move from scarcity to abundance has exacerbated self-control problems. Humans evolved in conditions where nutrition was scarce. Our brains are therefore hardwired to eat everything that comes our way while we’ve got the chance, and they’re surprisingly poor at signalling to us when we’ve had enough. For as long as food remained scarce - that is, relatively expensive - and work remained highly physical, there wasn’t a problem. But as we triumphed over scarcity the former balance was lost. Technological advances in the growing, transport, storage, preservation and cooking of food greatly reduced its cost to consumers. As humans have become more time-poor, we’ve seen an explosion in inexpensive fast food, all of it cunningly laced with those three ingredients our brains were evolved to crave: fat, sugar and salt. Then, on the output side, we’ve seen technological advance strip the physical labour first out of work and then out of leisure. We don’t play sport, we watch it being played and these days we don’t even go to the effort of travelling to the grounds.

There’s a third aspect to the problem of abundance: the increased resources devoted to the socially pointless pursuit of social status through consumption. When we have long passed the point where our basic needs for food, clothing and shelter are being satisfied, but our real incomes continue to grow by a couple of percent a year, we have to find something to do with the extra money. Partly, we spend it on ‘superior goods’ - goods you want more of as you get richer - such as health and education. That’s fine. But a fair bit of the extra income is spent on ‘positional goods’ - goods whose purchase is designed to demonstrate to the world our superior position in the pecking order. The point here is that, from the viewpoint of the community rather than the individual, the pursuit of status is a zero-sum game: the gains of those individuals who manage to advance themselves in the pecking order are offset by the loss of status suffered by those they pass. From the perspective of society, a lot of resources are simply being wasted.

So that’s the case for believing that, at this late stage in our development, the problem of scarcity has been superseded by the problem abundance. It has obvious implications for the environment and the need to integrate environmental and economic measurement. I like the example of commercial fishing. Two hundred years ago the constraint was the scarcity of human capital: not enough boats to haul in all the fish available. Today, after so much technological advance in the fishing industry, the scarcity problem is reversed: far too many boats chasing far fewer fish.

You don’t need to think for long about the SEEA exercise before you realise the paucity of measurement of the many dimensions of the environment and the changes in them over time. You realise how much of the bureau’s efforts are devoted to the myriad measurements needed to support the economic accounts. Our management of the environment should be much better informed just by the more comprehensive measurement of environmental indicators in physical values. When you covert those physical values to dollars and integrate them with the economic accounts you are (to quote one of the bureau’s documents) enabling analysis of the impact of economic policies on the environment and the impact of environmental policies on the economy.

For as long as we’ve been worrying about the economy’s effect on the environment the great bugbear has been the environment’s status as an ‘externality’ to the market economy and the price mechanism. The environment isn’t part of the system and it takes a lot of alertness and effort to incorporate it into the system, case by case. My dream is that, though environmental assets will continue to go unpriced until we find a way to price them, we may be able to short-circuit the process by incorporating environmental money values into the GDP bottom line.

Saturday, May 12, 2012

Why the budget isn't as contractionary as it looks

If you take the figures at face value, this week's budget is deeply contractionary, delivering a blow to demand at a time when parts of the economy aren't at all strong. But in economics, it's rarely wise to take things at face value.

There are different ways to assess the "stance" of fiscal policy - to work out the direction and size of the effect a budget will have on the economy. Settle back.

There's a two-way relationship between the budget and the economy. The decisions announced in the budget have an effect on the economy but, at the same time, the economy has an effect on the budget.

The budget contains elements - such as the progressive tax system and the availability of the dole to people without jobs - that have the effect of helping to stabilise the economy as it moves through the business cycle.

When the economy turns down, tax collections fall and more people go on the dole, which automatically worsens the budget balance. This worsening, however, helps to prop up (stabilise) the economy.

Then, when the economy starts to recover, these "automatic stabilisers" change direction. Tax collections grow faster than the rise in incomes and people find jobs and go off the dole. This improves the budget balance and also acts as a brake on the economy, stopping it from growing too fast and causing inflation problems.

These things happen automatically and their effect on the budget balance is called its "cyclical component". But governments can and do make their own decisions about increasing or decreasing taxes and government spending. The net effect of these discretionary moves on the budget balance is called its "structural component".

Now, when you assess the stance of budgetary policy the strict Keynesian way, you focus on the explicit policy decisions made in the budget (the structural component) and ignore the effect of the budget's automatic stabilisers (the cyclical component).

These days, however, the Reserve Bank and many economists tend to do it a simpler way that ignores the distinction between cyclical and structural. You just compare the budget balance for the old year with the planned balance for the new budget year.

The Treasurer, Wayne Swan, is expecting an underlying cash budget deficit in the financial year that's coming to an end, 2011-12, of $44.4 billion, but budgeting for a surplus of $1.5 billion in the coming year, 2012-13.

That's a turnaround of almost $46 billion. From one year to the next, the budget's net effect is to extract $46 billion from the economy - if it happens, the biggest one-year turnaround for almost 60 years.

It's equivalent to about 3 per cent of gross domestic product, which makes it absolutely huge. And since it's an extraction, you could only conclude it makes the stance of fiscal policy adopted in the budget highly contractionary. It would knock the stuffing out of the economy.

But here's where we mustn't take things at face value. Swan has had to move a lot of things around between years to make it possible to keep the Prime Minister, Julia Gillard's, election promise to get the budget back to surplus in 2012-13. When he's taken spending and pulled it forward into the last few weeks of the old financial year, that's not genuine for our purposes. For the government's accountants, whether something happens on June 30 or on July 1 makes all the difference in the world. You've got to draw the line somewhere, and that's where we draw it.

From the perspective of the budget's effect on the economy, however, a difference of a few days or a few weeks is a difference that doesn't make any difference.

And it turns out a big part of the $46 billion turnaround is explained by Swan's decision to draw spending forward into the last few weeks of the old year. There's compensation for the carbon tax (which doesn't start until July 1) of $2.7 billion, advance payment of natural disaster relief funds to Queensland of $2.3 billion, a bring-forward of infrastructure spending of $1.4 billion, the new "schoolkids bonus" cash splash of $1.3 billion, and financial assistance grants to local government of $1.1 billion.

That long list adds up to $8.8 billion. But here's the trick: when you take money out of one year and put it into the year before, you have twice the effect on the difference between the two years. So Swan's bring-forward of that spending explains $17.6 billion of the $46 billion turnaround.

Another thing to take account of is that the new year's budget is expected to benefit from increased revenue from resource rent taxes of $5.7 billion (that's from the existing petroleum rent tax as well as the new minerals rent tax). The point is that these taxes are explicitly designed to tax "economic rent", so they have no effect on the incentive to exploit petroleum or mineral deposits and thus have no effect on economic activity. A further factor is that, thanks to a quirk of public accounting, Swan's underlying cash surplus of $1.5 billion takes no account of the government's spending on the continuing rollout of the national broadband network.

The budget item "net cash flows from investment in financial assets for policy purposes" is expected to involve increased spending of about $6 billion in 2012-13. Not all of that would be the broadband network rollout. But to the extent it involves the government funding economic activity, it has the effect of reducing the budget's adverse effect on economic activity.

Put these three arguments together and you conclude the budget's drag on demand would be less than half the 3 percentage points of GDP we started with.

Even so, it's still a big effect. There's no denying the stance of fiscal policy is contractionary.

But the budget is only one of the factors affecting aggregate demand. It's also only one of the instruments available to the macro-economic managers to influence demand.

So if fiscal policy proves to be too tight, the obvious remedy will be to further loosen monetary policy - to cut the official interest rate, in plain English. The stance of monetary policy is already mildly expansionary and, if necessary, it can be made more so.

Is it a good thing to have the two arms of policy working in opposite directions? Sure it is - if you're hoping lower interest rates will lower our high dollar a little.

Such a lowering may have already occurred. If so, the effect will be expansionary.

Wednesday, May 9, 2012

How Swan did his budget trick

If you are having trouble seeing the horror budget we were told to expect, that's according to plan. This government has always wanted to be tough in principle, but never in practice.

For most people, Wayne Swan's fifth effort doesn't contain much that is nasty and includes a few things that are quite nice.

To be sure, it does include some nasties for higher income earners. Individuals earning more than $300,000 a year will have the tax on their superannuation contributions doubled to 30 per cent.

Executives face a crackdown on the taxing of their golden handshakes and living away from home allowances. And the new financial year will see the means-testing of the private health insurance rebate for singles on more than $83,000 a year and families on more that $166,000.

Why are higher income earners copping it? Because there aren't many of them and few of them vote Labor anyway.

For most other people, however, the budget isn't bad. Top of the list of unexpected goodies is a lump-sum bonus of $820 or $410 a schoolchild to parents eligible for the family tax benefit part A, to be paid next month in place of the education tax rebate.

The education rebate was just an election bribe, and so this is an easier-to-obtain bonus. Its primary purpose is to soften the blow of higher electricity and gas prices when the carbon tax starts in July.

Swan says the budget contains tax cuts, but these are modest (typically, $5.80 a week), limited to individuals earning less than $80,000 a year and - in combination with special increases in pensions and family benefits - will merely compensate for the higher energy prices.

Swan says this is a "fair go budget", with the government "doing everything we can to protect lower- to middle-income earners". But not if your income is so low you are part of the undeserving poor.

"Labor values" can run to the expense of a new handout to parents of schoolchildren, but can't afford to raise the dole of $35 a day by more than about 50?.

By contrast, small business owners get instant writeoffs of the cost of new assets worth up to $6500 each, and the ability to carry back losses.

Then there is increased spending on dental care, aged care and an early start to the national disability insurance scheme.

But how does all this new spending square with all we've been told about the herculean efforts Swan would need to transform this financial year's budget deficit of $44 billion into a surplus of $1.5 billion next year?

On paper, this would be the biggest one-year budget turnaround in many decades. And, is it a sensible thing to do anyway, at time when the economy's growth is so mixed?

The first thing making it less heroic than it sounds is that Swan has been moving the budgetary furniture around for two or three years in preparation for this great day. He has been "reprofiling" his planned spending, pushing it off into the future to make his task easier.

More recently, he has brought forward spending originally intended for the new financial year - including compensation for the carbon tax and the replacement for the education tax rebate - to the last weeks of the old year, thus exaggerating the true size of the turnaround.

The second explanation for the surprising dearth of budget pain is last week's decision to defer about $5 billion worth of defence spending.

Third is the expected recovery in tax collections, particularly from companies, and fourth combines the government's many decisions not to proceed with previously promised tax concessions.

All this shows how the budget can seem so tough arithmetically without actually being very. It also explains why the budget deficit turnaround won't deliver the blow to the economy some people fear.

In any case, the outfit with the ultimate responsibility for keeping the economy growing steadily, the Reserve Bank, is in possession of a safety valve it showed last week it isn't afraid to use.

Should the economy slow, it will cut the official interest rate again. And should the banks commandeer part of the decrease, it will cut the rate some more.

Monday, May 7, 2012

Reserve steals Swan’s budget forecasts thunder

While normal people are awaiting tomorrow night's federal budget to see if the measures Wayne Swan announces are naughty or nice, misguided souls in business and the financial markets are more interested in knowing Treasury's forecasts for the economy in 2012-13.

Well, wait no more. This year the key forecast for year-average growth in real gross domestic product in 2012-13 is the budget's worst kept secret.

It's taking the people who care about such things a long time to cotton on, but the Reserve Bank always upstages the budget forecasts by issuing its own forecasts as part of its quarterly statement on monetary policy on the Friday before the budget is unveiled on the second Tuesday in May.

This year the Reserve is forecasting year-average growth in 2012-13 of 3 to 3.5 per cent. This tells you Treasury's point forecast is likely to be at the mid-point of the range, 3.25 per cent.

And at a press conference on Friday Swan obliged by confirming that 3.25 per cent is indeed the budget forecast.

If you can't see why the Reserve's forecasts are such a reliable guide to Treasury's you understand neither the bureaucratic process nor the econocratic mind.

Although in theory the two outfits are free to each set their own forecast, in practice they caucus via the quarterly meetings of the joint economic forecasting group. And, in practice, it's rare for their forecasts for any indicator to be more than 0.25 percentage points apart - a difference which, in the highly imprecise world of forecasting, they dismiss as no more than a rounding error.

Just as politicians put their spin on developments, so the media put a spin on the news, preferring to focus on the negative. Thus it was reported that the Reserve "downgraded" its outlook for economic growth.

These cuts, we were told, "underscore the challenges facing the Gillard government" in returning the budget to surplus in 2012-13 - "a task made harder by the slowing growth and the resulting weaker revenue streams".

Don't you believe it. What rate of growth in 2012-13 was Treasury forecasting at the time of the midyear budget review last November? 3.25 per cent. What rate's it forecasting now? 3.25 per cent. That's harder?

It's certainly true the Reserve lowered many of its growth forecasts relative to those in its February statement. In general it cut each of its year-ended forecasts by 0.5 percentage points.

But note this: when it came to its year-average forecasts - those most relevant to the budgeting task - the one for 2012-13 was unchanged at 3 to 3.5 per cent and the one for 2013-14 was unchanged at 3 to 4 per cent.

Here's the point: the news the media didn't think worth passing on is that, notwithstanding its downward revisions, the Reserve is still forecasting that growth will accelerate from now on.

The latest actual figures we have for GDP show it growing by just 2.3 per cent over the year to December - about a percentage point below the medium-term "trend" rate of growth.

But the Reserve now has the pace quickening to 2.75 per cent over the year to this June, to 3 per cent over the year to this December, to 2.5 to 3.5 per cent over the year to next June, the same over the year to December next year and to 3 to 4 per cent over the year to June 2014.

But how, despite all the gloomy talk we keep hearing, can the Reserve forecast a reasonably early return to trend growth? As it explained in its statement on Friday, the answer turns on the reason its forecasts have been too high up to this point.

Ask every businessman and his dog why the economy isn't growing nearly as fast as the Reserve was forecasting and they'll tell you it's because the boffins underestimated the pain being imposed on the non-mining part of the economy by the high dollar.

But that's pretty much the opposite of the Reserve's explanation. It says most of the problem was its over-estimate of growth in production by the mining sector. It assumed the Queensland coalmines flooded in early 2011 would quickly be able to return to full capacity. In fact, it took them most of last year.

The Reserve also assumed new railway and port loading capacity would permit faster growth in mining production and exports than actually occurred.

It now has us returning to trend growth mainly because these problems have been overcome.

Saturday, May 5, 2012

Pre-budget primer: how pollies fudge the figures

When governments discover their self-imposed budget targets are harder to achieve than they expected, they face an almost irresistible temptation to cover the gap with a little creative accounting.

As we wait to see on Tuesday night the herculean efforts the Gillard government has made to keep its promise to achieve a budget surplus in 2012-13, let's review some of the tricks governments get up to when they find themselves in a tight fiscal corner.

We'll do so with help from an International Monetary Fund staff discussion note, Accounting Devices and Fiscal Illusions, written by Timothy Irwin.

"If history is a guide," Irwin says, "some of the efforts that should be dedicated to cutting spending or raising taxes may be diverted to the devices, that is, stratagems that reduce this year's reported deficit only by increasing subsequent deficits. As a result, fiscal adjustment may be partly an illusion."

That history is long. Irwin notes the term "fiscal illusion" was first used in 1897. He defines an "accounting device" as a manoeuvre that improves the headline fiscal indicator without actually improving public finances, or without improving it to the extent suggested by the headline indicator.

Irwin says fiscal illusions are a lot easier to produce when the budget balance is calculated on a "cash" basis rather than an "accrual" basis, though even the accrual basis isn't tamper-proof.

Under cash accounting, budget transactions are recorded at the time when cash is transferred; under accrual accounting, transactions are recorded at the time when economic value is transferred. Changing the timing of cash payments is relatively easy.

The private sector has used accrual accounting for eons but our governments switched from cash to accrual only in the late 1990s, at the behest of a new international convention for government financial statistics issued by the IMF.

State governments moved their budgets to an accrual basis, as required, and left it at that. The federal government moved to accrual in 1999, then had second thoughts and, while continuing to produce the bulk of its figures on an accrual basis, reverted to using the "underlying cash" budget balance as its headline fiscal indicator.

Treasury insists the cash balance is more meaningful as a measurement of the budget's effect on the macro economy but that's debatable. It wouldn't be lost on Treasury that cash accounting affords its political masters a lot more wriggle room.

Irwin says an accounting device aimed at the deficit reduces this year's deficit but increases future deficits by an amount that largely offsets the initial improvement.

"To do this, it must either increase reported revenue or decrease reported spending in the year (or years) of interest. And, in return, it either decreases reported revenue or increases reported spending in future years," he says.

This means accounting devices can be divided into four broad categories, the first of which is "hidden borrowing". This involves increasing reported revenue now but increasing reported spending later.

In Europe, governments have reduced their headline deficits by taking over the pension schemes of public enterprises. They receive a compensating payment for taking over the scheme, which they count as revenue, but the offsetting obligation to make future pension payments doesn't count as a liability.

In effect, they've borrowed money from the outfit selling the pension scheme but the debt doesn't appear in their books.

Another way of achieving the same effect is to sell government buildings, then lease them back. Ring a bell? The Howard government did this extensively in the late '90s. And it drove bad bargains with the lucky landlords on the other side of the sale-and-leaseback.

The second accounting device, "disinvestment", increases reported revenue now but reduces reported revenue in the future. The proceeds of privatisations are counted to reduce the deficit but, though these proceeds may reduce the government's debt and so reduce its interest bill, no account is taken of the future dividends the government will no longer receive.

In principle, the Howard government's introduction of the concept of the "underlying" cash balance brought an end to this disreputable accounting practice, much used by the Hawke-Keating government.

In practice, however, this applied only to the sale of financial assets (such as a whole enterprise), not to the sale of non-financial assets such as real estate (and hence, not to sale-and-leaseback deals).

The third accounting device, "deferred spending", reduces reported spending now but increases it later. In the US, the government once reduced its deficit by postponing a military pay day by a single day (shifting it from one year to the next) and, another time, by deferring Medicare payments that would have been made in the last week of the year.

"Less directly, governments sometimes defer maintenance of roads and other assets even though maintaining assets is ultimately cheaper than letting them deteriorate to the point at which they must be rebuilt," Irwin says.

Shifting payments between a bit before and a bit after June 30 is a favourite device of our federal governments, producing double the effect when people compare the new year's balance with the previous year's. Not quite so trickily, the Gillard government has been doing much "reprofiling" of its spending - bringing it forward or pushing it into the future in preparation for the promised return to surplus next financial year. But where spending is pushed back beyond the three years of the "forward estimates," it drops off the radar completely.

There are potentially legitimate reasons for governments to use "public-private partnerships" for the construction of things such as toll roads. "Yet often it is their illusory fiscal benefits that make them appealing," Irwin says. The construction costs and the consequent debt don't appear on the government's books, even though the government has assumed "debt-like obligations" for the future.

The fourth accounting device, "forgone investment", reduces reported spending now but reduces reported revenue later. You avoid building the infrastructure you should but this means you don't get the revenue you would have got from charging for the use of that infrastructure.

More seriously, inadequate public infrastructure may act as a drag on the economy's growth, thus causing general tax collections to grow more slowly than they would have.

This effect may be the dark side of Australia's apparent fiscal rectitude during Peter Costello's reign.

Yet another device is to have spending undertaken by a public entity that isn't counted as part of the budget for reporting purposes. Do the initials NBN mean anything to you?

Wednesday, May 2, 2012

Truth is almost always in the middle

I like Americans. I have American friends, and I remember a trivial incident that endeared me to Americans forever. We were in a funicular going up one of the hills surrounding Lake Como in Italy, at close quarters with a group of Yanks. They were joking and teasing each other in a way that struck my contact-deprived mind as very Australian.

But thanks to a great American institution, the Pew Research Centre, I now realise I think more like a European than an American on one of the central issues of economics and politics.

The centre's study of "American exceptionalism" asked samples of people in the US, Britain, Germany, France and Spain which was more important - being free to pursue your life's goals without interference from the state, or for the state to play an active role in society so as to guarantee that nobody was in need.

In the US, 58 per cent of respondents favoured individual freedom and 35 per cent favoured ensuring nobody was in need. In Europe, it was the other way round, with just 38 per cent of Brits favouring individual freedom and the proportion declining to 30 per cent by the time you got to the Spaniards.

A related question asked people if they agreed that "success in life is pretty much determined by forces outside our control". Only 36 per cent of Americans believed they had little control over their fate, compared with 50 per cent in Spain, 57 per cent in France and 72 per cent in Germany. Britain was the only European country surveyed where fewer than half (41 per cent) shared that view.

The joke of this is, despite the Americans' confident belief anyone can go from log cabin to White House if they try hard enough (the most recent proof positive being Barack Obama), studies show the US to have the lowest degree of social mobility - people actually making it from a poor start to a prosperous finish (or vice versa).

Individualism is very much a Western value (and, by the way, deeply embedded in the economists' conventional model of how economies work). I confess I've got a lot of the individualist in me. I like being free to do things my own way; I don't feel a compelling desire to be the same as other people.

At another level, however, I accept the need for the community to pull together towards common objectives, for us to be led by our elected leaders and for the better-off to be required to assist the less-well-off. I don't resent having the taxman redistribute a fair bit of my income to those less fortunate.

So I can see merit in both sides of the story. And one of the firmest conclusions I've come to about life and the economy is that the truth - and the right place to settle - is almost always to be found not at either extreme, but somewhere in the middle.

Just where in the middle is the hard part. We spend our lives searching it out - the more so because changes in the rest of the world probably cause it to shift over time.

The great temptation is to seek the simplicity and false certainty of either extreme - on this question of the ideal role of the state, libertarianism at one end and socialism at the other.

It's actually all the time I've spent hanging out with economists that's led me to the centre. Economics teaches that life's about optimising not maximising. We almost always face a range of desirable but conflicting, objectives. So all of one and nothing of the others is never the most desirable combination.

Economics is about trade-offs - about finding the particular combination of rival objectives that yields the most satisfaction. So life's about balance - "equilibrium" as economists say. Perhaps the modern term "the sweet spot" puts it better. We're searching for the place that gives us the best of all worlds - at least, the best available.

And yet our history shows us more inclined to swing from one extreme to the other. After World War II, people were dissatisfied with the way the economy was working. Particularly in Europe, they decided the answer was to nationalise all the key industries.

Flash forward to the 1980s of Maggie Thatcher and Ronald Reagan. People are dissatisfied with the way the economy is working so they decide the answer is to privatise all the key industries and deregulate the rest.

In the aftermath of the global financial crisis, the pendulum may be swinging back in favour of regulation.

The sweet spot in the middle is so hard to find. We keep falling for the simplicity and false certainty of extreme solutions.

The truth is the capitalist system does need to be protected from its own excesses, which could bring it - and us - crashing down. We were reminded of this truth in the recent crisis, from which the Europeans and Americans have yet to escape.

But, by the same token, we mustn't go to the opposite extreme of having the state attempt to solve all our problems and leave us imagining any remaining difficulties in our life must be the government's fault.

The truth is the government can't solve all our problems, and the more we abandon primary responsibility for fixing them ourselves, the more dysfunctional society becomes.

More than 70 per cent of Germans believe they have little control over their fate? It's all the fault of The System? They're just as misguided as all those Yanks believing hard work will get them to the top. As ever, the truth is a bit of both.

Monday, April 9, 2012

What Jesus said about capitalism

Most churchgoers see no great conflict between their beliefs and life in a market economy such as ours. But proponents of the little-known "sabbath economics" argue Christ's teachings have been reinterpreted over the centuries to make them fit with modern capitalism.

All I know about sabbath economics comes from the little book, The Biblical Vision of Sabbath Economics, by the Californian theologian and teacher Ched Myers. I'll give you my summary of the book provided you don't presume I'm an advocate. It's an interesting topic for an Easter Monday.

The name sabbath (the seventh day) is a reference to the biblical injunction - mainly honoured in the breach - that the Jews practice "jubilee". Every 50th year (the year following the passing of seven times seven years), slaves were to be freed, people were to be released from their debts and land returned to its original owners.

So sabbath economics involves an "ethic of regular and systematic wealth and power redistribution". You can see why this is an uncomfortable topic (for me as much as anyone else).

Many Christians would argue this Old Testament stuff was superseded by the New Testament, but Myers counters that the New Testament reveals Jesus as preoccupied with jubilee ideas.

"There is no theme more common to Jesus's storytelling than sabbath economics," he says. "He promises poor sharecroppers abundance, but threatens absentee landowners and rich householders with judgment."

It's certainly true that Jesus was always blessing the poor, challenging the rich, mixing with despised tax-gatherers and speaking of a time when the social order is overturned and "the last shall be first".

It's also true, as Myers reminds us, that many of Jesus's parables deal with clearly economic concerns: farming, shepherding, being in debt, doing hard labour, being excluded from banquets and the houses of the rich.

Myers alleges that many churches handle the parables "timidly, and often not at all". "Perhaps we intuit that there is something so wild and subversive about these tales that they are better kept safely at the margins of our consciousness," he says.

"Most churches that do attend to gospel parables spiritualise them tirelessly, typically preaching them as 'earthly stories with heavenly meanings'. Stories about landless peasants and rich landowners, or lords and slaves, or lepers and lawyers are thus lifted out of their social and historical context and reshaped into theological or moralistic fables bereft of any political or economic edge - or consequence."

Myers devotes a chapter to the incident of Jesus meeting the rich man, who asks "what must I do to inherit eternal life?" Jesus neither welcomes him into the club nor outlines the things he must believe to gain admission.

Rather, he tells the man to go and sell everything he has, give the money to the poor and then come back and follow him. But the man, unwilling to give up his wealth, rejects discipleship and goes away.

Jesus responds, "how difficult it is for the wealthy to enter the kingdom of God ... It is easier for a camel to go through a needle's eye than for a rich man to enter the kingdom of God."

"The clarity of this text has somehow escaped the church through the ages, which instead has concocted a hundred ingenuous reasons why it cannot mean what it says," Myers says.

His interpretation? Jesus is simply saying the kingdom of God is a social condition in which there are no rich and poor. So, by definition, the rich cannot enter - not with their wealth intact.

Myers says that in first century Palestine, the basis of wealth wasn't possession of consumer durables, but land. And the primary means of acquiring land was through debt-default. Small agricultural landholders groaned under the burden of rent, tithes, taxes, tariffs and operating expenses.

"If they fell behind in payments, they were forced to take out loans secured by their land. When unable to service these loans, the land was lost to the lenders. These lenders were in most cases the large landowners," he says.

This is how socio-economic inequality had become so widespread in the time of Jesus. It's almost certainly how the rich man ended up with "many properties", according to Myers. And these are just the circumstances the jubilee is intended to correct.

"Jesus is not inviting this man to change his attitude towards his wealth, nor to treat his servants better, nor to reform his personal life," he says. "He is asserting the precondition for discipleship: economic justice."

Myers offers his explanation of a much-quoted saying from which today's prosperous Christians derive comfort: Jesus's observation that "the poor will always be with you".

This doesn't mean Christ accepted poverty as an inevitable characteristic of the economy, or part of the divine plan. Rather, he says, the divine vision is that poverty be abolished, but as long as it persists, God and God's people must always take the side of the poor - and be among them.

"Privately controlled wealth is the backbone of capitalism," Myers says, "and it is predicated upon the exploitation of natural resources and human labour. Profit maximisation renders socio-economic stratification, objectification and alienation inevitable.

"According to the gospel, however, those who are privileged within this system cannot enter the kingdom. This is not good news for first-world Christians - because we are the 'inheritors' of the rich man's legacy.

"So the unequivocal gospel invitation to repentance is addressed to us. To deconstruct our 'inheritance' and redistribute the wealth as reparation to the poor - that is what it means for us to follow Jesus."

Saturday, April 7, 2012

How to improve investment advice to retirees

They say that at every stage of life the baby boomers reach, the world changes to accommodate their needs. So now the boomers are starting to reach retirement, it's the investment advisers' turn to lift their game.

To date, the superannuation industry's greatest attention has been paid to the accumulation phase: how much people need to save to ensure an adequate income in retirement. But the boomers' interest is switching to the retirement phase: how their savings should be managed to best effect.

And there are signs financial planners are working to improve the advice they give retirees. This seems clear from a recent speech by Dominic Stevens, of the annuities provider Challenger. Stevens made extensive use of an article by Joseph Tomlinson, "A Utility-based Approach to Evaluating Investment Strategies", published in the US Journal of Financial Planning. I'll be drawing on both sources.

To date, most advice to retirees has focused on "asset allocation" - how their investments should be divided between shares and fixed-interest securities - and on setting a safe rate at which money can be withdrawn and spent without it running out before the retiree dies.

Tomlinson's objective is to provide advice that is less one-size-fits-all, encompasses more eventualities and incorporates the insights of behavioural economics. These days, computers make it easier to provide more accurate advice and deliver it in user-friendly programs.

Remember, no one knows what the future holds. Who knows what will happen to the sharemarket - or any other financial market? So advice is based on reasonable assumptions and on averages, and advisers seek to estimate expected returns.

But more can be done to allow for the personal preferences of the particular retiree and to take account of the range of likely outcomes around the average.

The first issue is the "risk-return trade-off". The higher returns some investments offer - shares versus fixed interest, for instance - usually reflect a higher degree of risk: risk you won't get your money back, and risk that returns will vary a lot from year to year. It's generally accepted that old people who need to live off their savings can't afford to run the same degree of risk as young people with many years to recover from sharemarket setbacks.

These days more attention is being paid to "sequencing risk". Say you need to live off your savings for 15 years and it's reasonable to expect there'll be two bad years for the sharemarket in that time. Just when those two years occur makes a big difference.

If they come late, it won't be so bad; if they come early you could be almost wiped out and never recover. This suggests retirees need to hold more of their savings in fixed interest than many do.

In any case, most people are "risk averse". Consider this choice: which would you prefer, the certainly of earning $100, or a 50 per cent chance of earning nothing and a 50 per cent chance of earning $200?

If you were "rational" you wouldn't care either way because both options have the same "expected value" (for the second: 50 per cent of $0 plus 50 per cent of $200 equals $100).

If you much preferred the certain $100, that makes you risk averse (and normal). If you fancied the chance of walking away with $200, that makes you a "risk seeker". Risk aversion is pretty much the only departure from "rational" behaviour that economists regularly allow for.

A vital question in working out how much of your savings you should withdraw each year (a common rule of thumb is 4 per cent) is how long you'll live. You can't know, of course.

The advisers' standard approach is to look up in the government's actuarial life tables the average life expectancy for someone of your sex and age.

If the answer was 20 years, this would be used for your planning. But a lot of people will fall a bit below or a bit above the average, and Tomlinson's more sophisticated calculations take account of this wider range of probabilities. At present, the main objective in setting your withdrawal rate is to ensure you don't suffer "plan failure" - run out of money before you die.

The alternative to running out is to die with money left - the "bequest amount".

Conventional economics assumes that, dollar for dollar, your pain at having your money run out before you're ready to die would be equal to your pleasure at knowing you'll be leaving a bequest to your relos.

But this seems highly unlikely. As Stevens argues, if a retiree was living on $30,000 a year and that dropped to $20,000, it would have a more profound negative effect that the positive effect of income increasing to $40,000.

The two psychologists who pioneered behavioural economics, Daniel Kahneman and Amos Tversky, call this "loss aversion" (as opposed to risk aversion). They found that most people hate losing $100 about twice as much as they like gaining $100. Since running out of money before you die is a much bigger deal than losing small sums while you're working, it's likely retirees' loss aversion is a lot greater than the usual rate of 2:1. Some preliminary surveys suggest it might be as high as 10:1.

If so, this means retirees' desire to avoid running out of money (and having to fall back on the age pension) is a lot stronger than investment advisers' conventional calculations assume. And this, in turn, suggests retirees' choice of investments ought to be a lot more cautious than it often is.

Tomlinson argues that particular retirees' degree of loss aversion ought to be taken directly into account when determining the best investment strategy to meet their needs. When you do so, the bottom line of the calculation is not the average expected return on their savings but the average expected utility from those savings.

His refinement takes account of the possible size of plan failure - whether your savings are gone one year before you die or 10 years - not just whether or not failure is likely.

It also acknowledges the size of bequests is likely to suffer from diminishing marginal utility. Each extra dollar gives you less satisfaction than the one before.

Shifting the focus from expected returns to expected utility could make investment advisers' advice a lot more realistic and thus a lot more helpful.

Wednesday, April 4, 2012

How business is white-anting the weekend

Whether or not they realise what they're doing, Australia's business people, economists and politicians are in the process of dismantling the weekend and phasing out public holidays. And they're doing it in the name of making us better off.

Historically, the two arrangements that have protected the weekend and public holidays from encroachment by employers are state government restrictions on trading hours and the requirement in industrial awards that employees required to work at "unsociable hours" be paid an additional penalty rate.

Charging employers a penalty was intended to discourage them from making unreasonable demands on their employees unless absolutely necessary.

The first assault on community-wide days off came in the second half of the 1980s with the deregulation of trading hours as part of micro-economic reform.

Not much later, the move to bargaining over pay rises, and then bargaining at the enterprise level, allowed employers to push for penalty rates to be abandoned in return for higher "annualised" wages.

Employers inculcated the view penalty rates were an anachronism standing in the way of progress and modernity. Many still think that way. One of the goals of John Howard's Work Choices was to make it easier - and less expensive - for employers to get rid of penalty payments.

(Another of its provisions was to make it easier for workers to "cash out" part of their annual leave - to exchange days off for money. How this squared with the original rationale for forcing employers to give their workers paid holidays was never explained.)

Julia Gillard's Fair Work changes to Work Choices represented the first setback in the push towards the 24-hour, seven-day-a-week economy. They made it harder for employers to buy out penalty payments. And the "modern award" process - which replaced the various state awards with single national awards - inevitably involved increasing some penalty rates in some states.

But now the push has resumed. Last week, the NSW government moved to join Victoria in allowing all shops - not just those in the CBD - to open on Boxing Day. Now, say the retailers, all we need is for restrictions to be lifted on Easter Sunday.

And this week, the major banks revealed their intention to push for the definition of ordinary hours in the national banking award to be extended to include Saturday afternoons and all of Sundays. The banks say they'd still pay penalty rates, but the union doubts this promise would last. It says the banks' goal is to be able to roster employees to work any five days of the week without recognising traditional work patterns.

What's the banks' justification for seeking such a change? To promote "flexible and efficient modern work practices in a way that has proper regard to the considerations of productivity and employment costs".

Ah yes. It would make the economy more flexible and efficient, and thus raise productivity. Well, in that case, say no more. Silly me.

It's not hard to see why there's been so little public questioning of this push towards a 24/7 economy. It's highly convenient to be able to shop whenever we have the time. The more two-income families we have, the more we value the ability to shop throughout the weekend.

It also fits with the trend towards leisure being commercialised - becoming something we buy (a meal out, a show) rather than something we do (kick a football in the park with our kids).

But this belief that life would be better if shops, restaurants and places of entertainment were open all hours rests on the assumption you and I won't be among those required to work unsociable hours to make it happen. An even less obvious assumption is that the push for a 24/7 economy will stop when it has captured shopping and entertainment; it won't continue and reach those of us who work in factories and offices.

As usual, the "flexibility" being sought is one-sided. Employers gain the ability to require people to work - or not work - at times that suit their firm's efforts to maximise its profits.

If those times don't fit with your family responsibilities - or just with your desire to enjoy your life (you selfish person, you) - or if the boss's requirements keep changing in unpredictable ways, that's just too bad.

It's the price to be paid for getting more prosperous (with the boss's standard of living rising quite a bit faster than yours).

But this is the part of modern life that makes no sense to me.

Accepting the economists' argument that keeping the economy running for more hours in the week is more efficient and so will raise our material standard of living, how exactly will this leave us better off?

Why does being able to buy more stuff make up for husbands and wives being able to see less of each other, having less time with the kids, having a lot more trouble getting together with your friends, and having your day off when everyone else is at school or working?

Why is this an attractive future? Why should our elected representatives reorganise our economy in ways that suit business and promote consumption, but do so at the expense of employees' private lives?

This is a classic case of business people, economists and politicians urging on us a mentality that prioritises the economic - the material - over the other dimensions of our lives. Yet again, no one pauses to ask what these "reforms" will do to our relationships.

Why is it the politicians who bang on most about the sanctity of The Family are also those most inclined to make family life more difficult?

Monday, April 2, 2012

Let's slow down the mining boom

Innovative thinking is not only in short supply in Australia's businesses - as our weak productivity performance attests - it's also hard to find in the economic debate.

You could count on one hand the economists who do some lateral thinking and throw into the debate some new way of viewing a problem and overcoming the familiar difficulties.

But one economist who does come up with new ideas to think about is Dr Richard Denniss, director of the Australia Institute. He observes that while everyone's been debating whether the mining boom's a good thing or a bad thing, no one's focused on the obvious question: what rate of growth of the mining industry is consistent with the national interest?

And in a paper to be published today, written with Matt Grudnoff, he puts his conclusion: The Macro-Economic Case for Slowing Down the Mining Boom.

Why has this idea not occurred to anyone before? Partly because of the unthinking belief of almost all business people, politicians and economists that all economic growth is good and the faster the better.

When the new Queensland Premier announced his intention to speed up the approval process for new mines, most of the aforementioned would have nodded in approval. But why is faster than the economy can cope with better?

Partly, Denniss argues, because

of the way economists divide economic issues into micro and macro. As a micro issue the focus is on allowing private interests to make profitable investments as they see fit, with no more government intervention than is necessary to limit damage to the local environment.

As a macro issue the focus is on taking whatever strength of demand the private sector serves up and "managing" it to ensure it leads to neither excessive inflation nor excessive unemployment. If demand's too strong you raise interest rates to chop it back; if it's too weak you cut rates to beef it up.

But Denniss argues the boom's too big to fit this neat division. According to the Bureau of Agricultural and Resource Economics, there are 94 mining projects worth $173 billion at an advanced stage of development (plus a lot more at earlier stages).

For the miners to attempt such a huge amount of activity in such a short space of time inevitably creates what Denniss calls "macro-economic externalities" - adverse spillover effects on the rest of the economy, in the form of skilled labour shortages, wages pressure and probably a higher-than-otherwise dollar.

No one understands this better than the Reserve Bank, of course. But the higher-than-otherwise interest rates it has and will use to limit the inflation fallout from the boom aren't intended to (and couldn't be expected to) limit the boom.

Rather, they're intended to crimp the rest of us - in particular, consumer, housing and non-mining business investment spending - to "make room" for the boom-crazed miners. This will succeed in controlling inflation, no doubt, but what reason is there to believe it will lead to the most efficient allocation of the nation's resources?

Denniss suggests this thought experiment: if all of Australia's mineral resources were controlled by a profit-maximising monopolist, would it respond to the present exceptionally high world prices by building as many new mines as possible as quickly as possible?

Would a monopolist bid against itself for scarce labour and infrastructure capacity (to get the minerals to port and onto ships)? Or would it invest in training and infrastructure before it began expanding production?

His point is not to advocate monopoly, obviously, but to make clear the potential for conflict between the interests of the miners and the interests of the nation.

We are a monopolist in the sense that all the natural resources belong to us. Which means it's up to us to ensure they're exploited in the way that benefits us most. In this we need to remember the miners are largely foreign-owned (meaning we retain little of the after-tax profits) and the resources are non-renewable.

How much do we lose if they stay in the ground a little longer? Are we really expecting that within a decade or so the world won't be willing to pay much for them?

We're a monopolist also in the sense that it's our economy and we bear all the cost of the inflation and excessive exchange rate generated by the foreign miners' mad dash to expand production. We aren't a monopolist in the sense that we control the world supply of coal and iron ore, but we are big enough in the world market for our actions to have a significant effect on world prices.

A monopolist would be more inclined to sit back and enjoy the high world prices and less inclined to madly expand production and thereby undermine the high price (to coin a phrase). And to the extent a monopolist did expand, it would start with the most profitable opportunities and progress towards the least profitable.

Denniss's point is: why should we allow the miners to turn the decision about which mines get built first into a race rather than a ranking? And why should we bear the macro-economic costs generated by the miners' race to be first out the door with our resources?

He proposes that new mining projects be required to bid at auction for a set number of development permits. This would ensure the most profitable projects proceeded first.

And if you don't like the sound of that, he says the same effect could be achieved by removing the mining industry's present subsidies on fuel and alleged research and development spending.

Saturday, March 31, 2012

We risk letting lawyers stifle innovation

If our business people, economists and politicians are genuine in their desire to lift our productivity, rather than just moan about the Fair Work Act, they'll put reform of the regulation of intellectual property high on their to-do list.

Unfortunately, the minor changes to intellectual property regulation put through Parliament last week, to the accompaniment of great self-congratulation by the Gillard government, suggest the professed true believers in productivity improvement just don't get it.

If we're really concerned to encourage invention, innovation and creativity, nothing could be more central than the way we regulate intellectual property. But I get the feeling a lot of people have lost sight of what we're doing and why we're doing it.

So let's start with the basics. When governments grant patent or copyright protection they are intervening in the market to give particular individuals or businesses a monopoly over the commercial exploitation of that idea for up to 20 years.

When you've got a monopoly you're able to charge higher prices than if you had competitors selling access to the same idea. So why on earth would a government grant such favours?

Well, the rationale is to increase the monetary incentive for people to come up with inventions, innovations and creations that benefit the community. If I dreamt up some new thing, but other people were immediately able to copy it and compete with me, I wouldn't get much reward for my effort and ingenuity.

In which case, people like me won't be trying very hard to come up with new ideas. So the government grants inventors and creators a temporary monopoly over their idea to encourage more good ideas.

The point to grasp is that this approach involves a trade-off. The government imposes a cost on the community by effectively allowing rights-holders to overcharge for their products, but it does so in return for the greater benefits this brings to the community.

This suggests, first, that governments should never grant rights or enhanced rights to individuals and firms unless it's clear the granting of those rights leaves the community better off. Second, governments should always be checking to ensure the benefits to the public from the protection of intellectual property exceed the costs to the public of that protection.

Were the public costs ever to exceed the public benefits, the entire economic justification for the artificial creation of property rights would evaporate. It would be a classic instance not of "market failure" but "government failure".

The reason reform of intellectual property should be high on the productivity promoters' to-do list is that we seem to be drifting ever closer to the point where its costs exceed its benefits. That seems particularly true in the United States - and we look to be going the same way.

The US plays a pivotal role in the globe's intellectual property. It's at the frontier of technological change and creativity, and is a net exporter of intellectual property to every country in the world. Increasingly, intellectual property, designs for new machines, pharmaceuticals, electronic gadgets, films, TV shows, books, recordings and much else, is the main thing the US sells the world.

These days, making the world a safer, more profitable place for American intellectual property is the main objective of US trade policy - as we found when we negotiated the misnamed free-trade agreement with the US in 2004. We were pressured to make our laws fit with the Americans', and we'll get more pressure to become more like them in all future trade negotiations.

So what's the problem? Much of it is that the whole area has been taken over by lawyers. It's become hellishly legalistic, complicated, loophole-ridden and expensive. In the process, the lawyers have lost sight of the economic object of the exercise. It's become an area of endless battles between businesses arguing over their rights.

The other part of it is that powerful industry groups have taken to lobbying politicians to change the law in ways that advance their interests without benefit to the public. And US businesses increasingly engage in game-playing in the hope of ripping each other off.

American pollies are often persuaded to extend the life of intellectual property protection retrospectively, which obviously does nothing to encourage innovation in the past.

The patent system has been extended to cover software (which was already copyright) and even business methods. It's too easy to get a patent - you can get them for very obvious ideas - and patents can be too broad, covering yet-unthought-of uses.

You can get a patent for something that's very similar to someone else's patent. But because they're handed out so easily, you often don't know whether a patent is valid - whether his patent beats your patent - unless you spend between $5 million and $7 million battling it out in court. The high cost of litigation means big businesses regularly intimidate small businesses.

This problem of "fuzzy boundaries" to patents is so bad some businesses make a living as 'patent trolls' buying up dodgy patents, then threatening to sue legitimate patent-holders. The victim pays what amounts to protection money to avoid the higher cost of a court battle.

You've no doubt heard of the huge patent battle between Apple and Samsung being fought in courts around the world. Which side has the legitimate patents for tablet technology?

Pharmaceutical companies use a trick called "evergreening" to stop their patents expiring, which would have allowed competition from generic drug producers to slash the prices they can get for their drugs.

The owners of intellectual property rights often attempt to use them to protect themselves from losing business to firms developing more innovative ways of doing things.

Just as undesirable, researchers trying to develop better products can be held back by the prohibitions or high costs imposed by existing patent holders (some of which may not be legit).

It's got so bad in the US that, according to the calculations of a leading academic campaigner for patent reform, James Bessen, of Boston University school of law, for all US patents bar those for chemicals and pharmaceuticals, earnings from their patents are more than exceeded by the cost of litigation to protect those patents. He calls this a "patent tax".

If he's right, the intellectual property system has degenerated to the point where it's actually inhibiting innovation. We're being forced to pay higher prices, but getting nothing in return.