Monday, February 25, 2013

Swan tries to legislate for budget honesty

It's too much to hope this year's election campaign will be a "contest of ideas" or even a debate over the pros and cons of the parties' rival policies. But one thing I confidently predict: there'll be endless arguing over the cost of promises and where the money will come from.

For maybe 30 years the people who worry most about maintaining budget discipline - the econocrats in Treasury and Finance - have striven to discourage politicians from engaging in election bidding wars they don't know how they'll pay for. Last week this unending struggle took another lurch forward.

The econocrats have tightened things up by persuading their political masters to impose restrictions on their own freedom of action. They've had more success in this than you'd expect, mainly because, when it comes to being fiscally cavalier, governments are at a disadvantage to their opponents.

It's a rare case of the disadvantages of incumbency. Governments' actions are scrutinised more closely than oppositions' are, and they can escape neither the higher obligations of office nor the sober counsel of their bureaucratic advisers.

At present, the need for fiscal responsibility weighs heavily on the Gillard government, with its hugely expensive plans for a National Disability Insurance Scheme and the Gonski education reforms but, as yet, no indication of how they'll be paid for. But Julia Gillard has already accepted she has no choice but to spell out in the May budget a longer-term plan for funding them.

That being so, the new measures to increase budgetary "transparency" Wayne Swan announced on Friday are no doubt aimed at turning up the heat on Tony Abbott, who has his own list of expensive promises he hasn't yet said how he'd pay for, and may have been hoping he'd be able to skid through the campaign without revealing much.

The econocrats' long campaign to discourage irresponsible election promises began early in the term of the Hawke government, which was persuaded to add to the published budget figures for the coming financial year the "forward estimates" for the following three years. Surely this would be long enough to reveal any plans that could lumber the budget down the track? As it's turned out, it wasn't. In Swan's last few budgets he's been using a kind of fiscal bulldozer to push his ever-mounting spending commitments off into the invisible years beyond the forward estimates.

The next advance came with Peter Costello's charter of budget honesty in 1998. In the election campaign of March 1996, the Keating government failed to disclose how much the budget balance had deteriorated since the previous May. It also sought to conceal the size of its deficit by counting the proceeds from asset sales.

Costello made much of the "black hole" he discovered on coming to government and used it to justify breaking a lot of spending promises retrospectively declared to be "non-core". (In this he was using the same device Paul Keating used against the Fraser government when Labor came to power in 1983.)

As well as seeming to outlaw the use of asset sales to fudge the budget balance (while actually leaving a few loopholes Swan happily jumped through in this year's budget), the honesty charter sought to end for ever the possibility of black holes by instituting the "pre-election fiscal and economic outlook" document.

Whenever an election is called and the writs issued, the secretaries of Treasury and Finance have up to 10 days to issue, in their own names, updated economic forecasts and budget estimates. That's fine - though successive oppositions have used it as a reason to delay issuing any policy costings until they know what it says.

The honesty charter also sought to improve the costing of election promises by permitting both the government and the opposition to submit their policies for costing by Treasury and Finance during the campaign.

But this arrangement was biased in favour of the government of the day (which can get its policies costed by the same people before the campaign starts, thus minimising the chance of embarrassment).

Oppositions have refused to play by these rules. But, under its agreement with the independents, the Gillard government has established the Parliamentary Budget Office to provide all parties with Treasury-quality costing advice any time up to the election campaign.

Even so, it's not clear the Abbott opposition will use the office's services to make its costings public in good time before the election. Which brings us to the latest effort to tighten up on parties attempting to get through the campaign without adequate disclosure of where the money's coming from.

Labor will seek legislative approval for the budget office to conduct a post-election audit of each political party, publishing within 30 days of the election full costings of their election promises and their budget bottom line.

So, should any party make it through the campaign without honestly disclosing the cost of their commitments, their dishonesty or incompetence would soon be revealed. It's not hard to see this measure is aimed at forcing the opposition to be more forthcoming than it was in the 2010 election, when its unchecked costings proved to have a hole of up to $11 billion.

And, should Labor lose the election, the audit would prevent the new government from exaggerating the size of any "black hole" it left. To all but the politically one-eyed, Labor's ulterior motives don't stop such audits being a good move. The noose is tightening on irresponsible vote-buying.

But with competition between the parties becoming ever more intense - and voters ever more easily distracted by election trivia - it's hard to believe audits would eradicate budget dishonesty.

Saturday, February 23, 2013

Economy's 'fast lane' bigger than you think

THE biggest thing that worries many people about the resources boom is that word ''boom''. Booms are cyclical, and thus temporary. So it's not surprising so many people worry about what we'll be left with when the boom's over.

This week, two economists at the Reserve Bank, Vanessa Rayner and James Bishop, published a research paper neatly answering that concern. In short, what we'll be left with is a very much bigger mining sector.

The trick is that this boom is actually as much structural (lasting) as cyclical. Australia has had commodity booms in the past, and almost all of those were transitory.

From about 2004, the prices of coal and iron ore began rising strongly until they'd taken Australia's terms of trade - the prices we receive for our exports relative to the prices we pay for our imports - to their most favourable level in 200 years.

The main thing making this price boom so different (apart from it lasting a lot longer) is that it precipitated a second boom: investment in the expansion of existing mines and the building of new mines and natural gas facilities.

Now, the boom in prices ended more than a year ago and it seems the boom in mining investment is close to its peak. That is, the amount of money being spent on expanding our mining production capacity will stop growing each quarter and start declining.

Even so, we'll still be investing a lot more on mining each quarter than we usually do. So we're far from reaching the point where our mining production capacity stops expanding.

And that still leaves this play with a third act that's only just started: a huge increase in our production and export of minerals and energy as we take up the newly expanded capacity.

Thus you see why this ''boom'' is as much structural as cyclical. It represents a historic and lasting change in the industry structure of our economy, achieved over a relatively short period.

But just how big is mining after all this expansion? The miners' critics - particularly the Greens - make it seem the industry is pathetically small, whereas the industry itself tries to exaggerate its size and importance.

The Reserve Bank researchers adopt a wider definition of mining than that used by the Bureau of Statistics, partly because they're trying to get a more realistic estimate of the size of the part of the economy that's been the primary beneficiary of the boom and the size of the ''fast lane'' of the two-speed economy.

They establish the size of the ''resource extraction sector'', starting with the standard six components: coal, oil and gas, iron ore, non-ferrous metals, non-metallic minerals, and exploration and mining services.

But then they add those industries involved in smelting and refining the minerals before export - iron smelting, oil refining and liquefying of natural gas, and the refining of bauxite to form alumina and the smelting of other non-ferrous metals, including copper, lead and zinc - which the bureau class as part of manufacturing.

According to the researchers' estimates, in the eight years between 2003-04 and 2011-12, the resource extraction sector's share of nominal ''gross value-added'' (essentially, gross domestic product) grew from less than 7 per cent to 11.5 per cent. Of this 11.5 percentage points, the narrowly defined mining industry accounts for 9.75 points, with the processing and refining part of manufacturing accounting for 1.75 points.

Most of this growth is explained by the higher export prices being received. That's mainly because the strong growth in the volume of iron ore production to date has been offset by a fall in the production of some other minerals, particularly oil.

Next the researchers estimate the size of ''resource-related activity''. This includes the investment spending on expanding the future production of minerals, as well as the provision of ''intermediate inputs'' used in the present production of minerals.

''In other words,'' they say, ''it captures activities that are directly connected to resource extraction, such as constructing mines and associated infrastructure, and transporting inputs to, and taking extracted resources away from, mines. It also captures some activities less obviously connected to resource extraction, such as engineering and other professional services (legal and accounting work, for example).''

Over the eight years to 2011-12, this resource-related activity has more than doubled as a share of GDP, from less than 3 per cent to 6.5 per cent. Within that 6.5 percentage points, business services account for 2.25 points, construction for 1.25 points, manufacturing for 1 point and transport for 0.75 points.

Note, this inclusion of the inputs provided to the mining industry isn't the same thing as the usual shonky attempts to put a figure on an industry's ''multiplier effect''. For one thing, it takes no account of the effect on other industries of the spending of income earned by mining employees or shareholders. For another, the researchers take care that the inclusion of inputs provided by other industries involves no double counting.

Put the resource extraction sector together with the resource-related activity and you find the size of the ''resource economy'' doubled to 18 per cent of GDP over the eight years to 2011-12.

According to the researchers' estimates, this 18 per cent of total production of goods and services includes well over 16 per cent of manufacturing's output, 16 per cent of construction activity and 15 per cent of transport activity.

Since 2004-05, this fast-lane ''resource economy'' has grown in real terms at an average rate of 7.5 per cent a year, whereas the rest of the economy has grown 2.25 per cent a year - a smaller gap than some imagine.

Because mining is so capital intensive, one way to denigrate it and minimise the significance of its expansion is to note that its share of total employment (as opposed to total production) is a mere 2.3 per cent. But according to the researchers' estimates, when you include minerals processing with mining proper, its share of total employment rises to 3.25 per cent. And when you add the more labour-intensive resource-related sector, it accounts for about 6.75 per cent of total employment, taking the share of the ''resource economy'' to just less than 10 per cent of total employment.

Don't let anyone tell you the resources boom is no big deal.

Wednesday, February 20, 2013

How to cut crime and the cost of crime

Although many types of crime have been declining over the past decade, there's still far too much of it. It's costing us too much, not only in losses to life, limb and property but also in worry that we may become victims.

Then there's the cost of all the insurance we need to take out and the cost of making our homes burglar-proof. Finally, there's the rapidly growing cost to the taxpayer of policing ($9.5 billion a year across Australia), the criminal courts (getting on for $1 billion a year) and the prison system (more than $3 billion a year).

You get the feeling all our efforts aren't acting as much of a deterrent. The more police we employ, the more arrests we get, and the more we increase punishments, the more people we have in overcrowded prisons.

Is there a way we can improve the effectiveness of our efforts so we have less crime and could spend less on crime control? Mark Kleiman, a professor of public policy at the University of California, Los Angeles, believes there is. He will expound his views at a conference on applied research in crime and justice in Sydney next week but, in the meantime, I can give you a preview.

Kleiman says we should be aiming for the minimum amount of punishment necessary to achieve the desired amount of crime control. Why? Because punishment is a cost, not a benefit. The benefit we're seeking is reduced crime, whereas punishment is a cost of achieving that benefit. Punishment comes at the expense of innocent taxpayers.

Putting it another way, we should keep clear in our minds that the objective of punishment isn't retribution, it's deterrence.

So how can we make our punishment more effective in deterring crime? Kleiman's thesis is that increasing the severity of punishment isn't cost-effective but making it swift and certain is.

"Theory and evidence agree: swift and certain punishment, even if not severe, will control the vast bulk of offending behaviour," he says.

Severity is not only a poor substitute for swiftness and certainty, he says, but also their enemy. That's because the more severe a sanction is, the less frequently it can be administered (prison cells are scarce) and the less quickly it tends to arrive.

It shouldn't be hard for any parent to believe that threats of punishment are more effective if the child knows an offence will be punished and that the punishment will be immediate. The trouble with our crime control efforts is that many crimes go undetected and so unpunished - you have a pretty high chance of getting away with it - and, even when offences are punished, the punishment comes months or years later.

Kleiman reminds us of the goal we should aim for: "the perfect threat never needs to be carried out". Achieve that effective deterrence and you've got the benefit of reduced crime without the cost of punishment. We could never reach that ideal but the closer we come the better.

Kleiman's analysis, influenced by the insights of behavioural economics, is an advance on conventional economics, which assumes severity is an adequate substitute for the certainty of being caught and ignores the question of swiftness.

All very logical but how do you put it into practice? Clearly, it would be impossible to make punishment of all offences swift and certain. But Kleiman observes our resources are spread very thinly. Instead, we should concentrate them, starting somewhere with a geographic region, a set of offences or a set of offenders.

You borrow resources from elsewhere and raise the certainty and swiftness of punishment until you reach the tipping point where offenders get the message and the rate of violation tips from being high to low.

Because offending is subject to positive feedback - a violation rate that's high will tend to stay high, whereas one that's low will tend to stay low - you can then move the resources to the next priority area. The reduction in offences will have increased the resources available.

Kleiman recommends focusing on those offenders subject to supervision in the community: people given community service orders rather than being sent to prison and prisoners let out on parole before their sentence is complete.

"As things stand, the community corrections system reproduces the flaws of the larger criminal justice system, having more rules than can be reliably enforced and imposing sporadic but sometimes severe sanctions," he says.

A small set of rules, each clearly linked to the goal of reducing re-offending, adequate capacity to monitor whether those rules are being observed and a system of swift, reliable and proportionate penalties to back up those rules would perform much better.

"If we can make community corrections a genuine alternative to incarceration - in other words, if we can learn how to punish people and control their behaviour when not paying for their room and board - we can have less crime and less incarceration, to the benefit of victims and offenders alike," Kleiman says.

For property and violence offenders who use drugs (a mighty lot of them), drug testing with swift and certain punishment can reduce their drug use, their reoffending and their time behind bars far more effectively and more cheaply than any drug treatment program or rehabilitation program, Kleiman argues.

The bad news is that present policies leave us with unnecessarily high levels of crime and incarceration, he says.

The good news is that just by making effective use of things we already know how to do, we could reasonably expect to have half as much crime and half as many people behind bars 10 years from now.

Monday, February 18, 2013

Mining tax message: no bipartisanship, no reform

WHEN governments stuff up in a democracy we think the solution is obvious: toss 'em out and give the other lot a go. But if you want a democracy that also delivers good government, it ain't that simple.

For too long, the private partisanship of those who want to see good economic policy lead to good economic outcomes has blinded us to an obvious truth: if you look back at the reform we've implemented, you find almost all of it happened because it had the support of both sides.

It's been too easily forgotten that all the potentially hugely controversial reforms of the Hawke-Keating government - deregulating the financial system, floating the dollar, phasing out protection and moving to enterprise bargaining - were supported by the Coalition.

Amazingly, the last big move to slash protection came during the depths of the recession of the early 1990s, when unemployment was on its way to 11 per cent. Dr John Hewson's big criticism was that Labor should have been bolder.

How did Labor have the courage to do such things? It's simple: it knew any adversely affected vested interests would get no sympathy from its political opponents.

Most Australians - even those who follow politics closely - don't realise how obsessed politicians are by the likely reaction of their opponents to anything they do; how much the policies of the opposition affect the policies of the government.

After Paul Keating failed to win his party's support for a broad-based consumption tax in 1985, he set his face against a goods and services tax. His scaremongering over Hewson's proposed GST was the main reason he won the unwinnable election of 1993.

After Keating's demise at the following election, the Labor opposition abandoned all bipartisanship on economic reform, running another scare campaign against John Howard's GST plan at the 1998 election and going close to defeating him.

This makes the GST the honourable exception to the rule: the only major economic reform we've seen survive without bipartisan support.

And it brings us to the mining tax. Let me be crystal clear about this: Labor has made an almighty hash of the minerals resource rent tax, revealing an abysmal level of political nous, moral courage and administrative competence.

It failed to release the Henry tax reform report for discussion well before announcing its decisions (thereby catching the miners unawares), failed to explain an utterly mystifying tax measure (and, before that, press Treasury to come up with something more intuitive).

It failed to stop the entire business community joining the miners' crusade against the tax, failed to counter the economic nonsense the miners peddled in their TV ad campaign, and failed to hold its own in the negotiations with the big three miners, allowing them to turn the tax into a policy dog's breakfast that, at least in its early years, would raise next to nothing.

In all this Kevin Rudd has to take much of the blame (for lacking the courage to release the Henry report early), Wayne Swan has to take much of the blame (for not putting Treasury through its paces and being so weak at explaining the tax) and Julia Gillard has to take much of the blame (for decapitating Rudd and then being so desperate to rush to an election she was prepared to agree to anything the miners demanded, without proper Treasury scrutiny).

After all that, Labor deserves no mercy. But the truth is Tony Abbott also played a part in lumbering the nation with a bad tax.

The case for requiring the miners to pay a higher price for their use of the public's mineral reserves at a time of exceptionally high world prices (even now) is strong.

Remembering the miners are largely foreign-owned, a well-designed tax on above-normal profits is a good way to ensure Australians are left with something to show for all the holes in the ground.

Similarly, the argument that a tax on "economic rent" (above-normal profit) is more efficient than royalty payments based on volume or price is strong, as is the argument that taxing economic rent should have no adverse effect on the level of mining activity. Relative to royalties, quite the reverse.

But Abbott cared about none of that. His response was utterly opportunistic. He would have opposed the tax whether it was good, bad or indifferent.

He saw an opportunity for a scare campaign and he took it, particularly when it became clear the big three miners were out to defeat the tax by bringing down the government and so would have bankrolled his election campaign.

It was fear of what Abbott would say that prompted Labor to delay the release of the Henry report until it could rule out most of its controversial recommendations.

It was the success of Abbott and the miners' joint campaign against the tax that, added to his loss of nerve on the emissions trading scheme, made Rudd vulnerable to his enemies within Labor.

And it was Abbott's strength in the polls that made Gillard so anxious to square away the miners at any cost and rush to an election while her (as it turned out, non-existent) honeymoon lasted.

But noting Abbott's share of the blame isn't the point. The lesson for people hoping for economic reform is that unless they're willing to use what influence they have to urge bipartisanship on their own side, they should expect precious few further advances.

Saturday, February 16, 2013

The little we know on how poor countries get rich

Despite the contrary impression they like to convey, there's a lot economists don't know. And in various parts of their discipline fads and fashions change without much real progress being made. Take development economics, the study of how countries develop economically, growing their production and consumption of goods and services until they move from being poor to being rich.

In his book, The Quest for Prosperity, Justin Yifu Lin - who spent four years as the World Bank's chief economist before becoming the director of the China centre for economic research at Peking University - reviews the progress of development economics and sums up the latest thinking.

Economists have specialised in the study of economic development since the end of World War II. How can a country accelerate its growth and wealth creation to move from a low-income agrarian economy to an industrialising middle-income economy and proceed to a post-industrialising high-income economy? And what are the respective roles of the public and private sectors in this transformation?

In 2006 the World Bank set up a commission to report on growth and development, noting the ''increasing evidence that the economic and social forces underlying rapid and sustained growth are much less well understood than generally thought; economic advice to developing countries has been given with more confidence than justified by the state of knowledge''.

The sad truth is that, since the war, only about 13 countries have made the transition to being high-income economies, with many progressing from the bottom only to get caught in the ''middle-income trap''.

In the early period after the war the dominant view among development economists was highly distrustful of markets and so highly interventionist.

''It held that the market encompassed insurmountable defects and that the state was a powerful supplementary means to accelerate the pace of economic development,'' Lin says. ''Many development economists then advocated that the state overcome market failures by playing a leading role in the industrialisation push, directly allocating the resources for investment and setting up public enterprises in the large modern industries to control the 'commanding heights'.''

These ''structuralists'' believed international trade couldn't be relied on as an engine of growth because any attempt to increase exports of commodities would simply worsen the developing country's terms of trade. They argued that the way for a developing country to avoid being exploited by developed countries was to develop domestic manufacturing industries behind high tariff barriers, a process known as ''import substitution''.

These attitudes continued to dominate until it became apparent they weren't working. In the 1980s, the pendulum swung to the opposite extreme. The ''Washington consensus'' - so called because it was enthusiastically adopted and imposed by the Washington-based international agencies, the International Monetary Fund and the World Bank - emphasised macro-economic discipline (limited accumulation of government debt), a market economy and openness to international trade and foreign investment.

But this ''neo-liberal'' approach fared little better. ''In terms of growth, employment generation and economic stability its results were disappointing, and some economists referred to the 1980s and '90s as 'lost decades' for developing countries,'' Lin says.

He says the main reason it failed to deliver was that it relied on an idealised set of market institutions - including well-functioning commercial laws and social norms of behaviour - which hardly existed in developing countries and weren't fully present even in the advanced economies.

Get this: when you look at those few countries that have moved up the industrial and technological ladder, you find they ''have rarely followed the policy prescriptions of the dominant development paradigm of the time.

''Most successful developing countries ? have expanded their manufacturing bases and moved into more sophisticated industrial products by defying conventional wisdom. In their development process, they pursued an export-promotion strategy instead of an import-substitution strategy ?

''And they each had a proactive government helping the private sector enter new industries instead of relying on market competition alone as advocated by the Washington consensus.''

Lin argues there's no simple, uniform formula for developing countries to follow. The strategy they adopt has to be adapted to their peculiar circumstances. Even so, the World Bank's growth report does identify five ''striking points of resemblance among all highly successful countries''.

First, they made the most of globalisation, importing ideas, technology and know-how from the rest of the world and exploiting global demand, which provided an almost infinite market for their exports.

Second, they maintained a stable macro-economic environment, despite periods of high inflation and public debt. Third, they had high rates of saving and investment, reflecting their willingness to forgo current consumption in pursuit of higher incomes in the future.

Fourth, they adhered to a market system to allocate resources. Their governments did not resist market forces in reallocating capital and labour from industry to industry. Fifth, they had committed, credible and capable governments.

In some countries, such as Hong Kong, the administration chose a laissez-faire approach (though it also had quite a number of sectoral policies), whereas in others the state was more hands-on, intervening with various tools (tax breaks, subsidised credit, directed lending) in the world of business to help private firms enter industries they might not have otherwise considered. The growth report also identified a series of ''bad ideas'' to be avoided by policymakers in their search for economic growth.

The list includes subsidising energy, using employment in the civil service to reduce joblessness, reducing budget deficits by cutting spending on infrastructure investment, providing open-ended protection to domestic firms, imposing price controls to stem inflation, banning exports for long periods, resisting urbanisation, measuring educational progress by the increase in school buildings, ignoring environmental issues as an ''unaffordable luxury'' and allowing the exchange rate to appreciate excessively.

It's clear Lin is a very bright chap and his book offers a valuable and balanced account of the progress and present state of development economics.

But it is marred by an amazing, credibility-destroying omission: in more than 300 pages about how the developed countries can raise their material living standards to those of the rich world, nowhere does he mention the challenge of climate change or the implications of such growth for the natural environment.

Like so many economists, he simply assumes the ecosystem away.

Wednesday, February 13, 2013

What I've taken 39 years to learn

Keynes was wrong. He famously said that in the long run we are all dead. But since last week I've been an economic journalist for 39 years and I'm still alive to tell the tale. On Wednesday I turn 65, but I'm enjoying the eternal short run too much to want to retire.

I'm hoping to keep hanging around until it's obvious I've worn out my welcome with the readers or with my boss, but I doubt I'd stay long were Fairfax to fall into the hands of people who lacked a commitment to the preservation of quality independent journalism.

Scholars argue over what Keynes meant by that aphorism. Like many such quotes, people use it to mean whatever suits them. I've always taken it to mean we should focus on managing the short-run fluctuations in demand (spending) and not worry about the supply (production) side of the economy, which neo-classical economics teaches can change only in the long run.

If that's what Keynes meant then he WAS wrong. As he well knew, the long run of economic theory isn't long enough for many of us to have died. But if you ignore the supply side for long enough it starts to malfunction, and this inevitably makes it harder to manage the demand side and keep unemployment and inflation low.

That's the point we'd got to when I started as an economic journalist in the mid-1970s: both inflation and unemployment were out of control - here and throughout the developed world - and economists were at a loss to know what to do about it.

In the end Australians stumbled on the solution half by accident. Paul Keating championed a program of extensive supply-side reform (he called it "micro-economic reform") and Johns Hewson and Howard supported him. This reform intensified the competition in many of our industries, reducing firms' pricing power and unions' bargaining power and making the economy much less inflation-prone. With inflation back under control by the early '90s, we slowly ground the official unemployment rate down to 5 per cent or so.

What's kept me going all these years - this year will be my 39th federal budget - is that I keep learning more about the economy and economics and as I learn my views evolve.

I'm very much aware of the material benefits supply-side reform and greatly improved demand management have brought us: ever-rising real incomes and more than 20 years since the last severe recession - something no other rich country can say.

But I'm also becoming more aware of the less tangible, less easily measured price we've paid for our greater affluence: a more materialist culture (where, for instance, education is valued mainly for the better jobs it brings), a wider gap between rich and poor, a more commercialised approach to entertainment and sport (with intrusive sports betting, drug-using athletes, unapologetic exploitation of pokie addicts and now maybe even corruption), a more degraded natural environment, a chief-executive class that expects everything its own way, a lot more job insecurity, more pressure on families and, I dare say, a lot more stress all round.

Let me be clear: most of us ARE better off materially as a result of the harsher, more demanding, less fair world we've built for ourselves. Were we to try to slow down the merry-go-round there WOULD be a material price to be paid.

But too much of the message we get from our business people, economists and politicians demands we go further and faster down this track and fails to acknowledge the choice we could make to live in a less-pressured, more leisurely, less uncaring world were we willing to get richer more slowly (and, heaven forbid, allow other countries to pass us in the eternal race for riches).

Paradoxically, all my time specialising on the economy has convinced me there's more to life than economics. We're giving too high a priority to the material and paying too little attention to the social, the relational and the spiritual. The community and its elected leaders are allowing economists to dominate policy advice when we should be consulting a much wider range of experts, including psychologists, sociologists, ethicists and even clerics.

But the people with most influence aren't the economists, it's the comparative handful of macho-man (and the odd alpha-female) chief executives whose interests the economists too often serve (along with a Greek chorus of business lobby groups and think tanks).

With assurance as to their rightness and righteousness, our big business leaders promise us more jobs and greater prosperity if only we'll see reason and give them freedom to do as they see fit and as soon as possible.

They're right about the jobs. If all we want is more jobs for more people, giving business freer rein will deliver them. What they rarely if ever admit (and the economists often neglect to warn us of) is that in many cases the extra jobs will be less secure and more pressured and the greatest beneficiaries of the extra income will be the business leaders themselves.

Central to big business's high pressure tactics is urgency. All "green tape" must be cleared away. Consider the community concern about the exploitation of coal seam gas. I suspect many people's worries about the wider effects of fracking are unfounded. But the scientific investigation is incomplete. Do we have time to wait until we know more? Gosh no. Projects must start immediately. What exactly is the hurry? A good question our politicians too seldom ask.

We're being hurtled towards a world I fear we will increasingly dislike. But in this democracy, that will be OUR fault, not anyone else's.

Monday, February 11, 2013

Reserve Bank burst bubble of certainty about future

There's never any shortage of people convinced they could do a much better job of managing the macro-economy than the outfit that does manage it, the Reserve Bank. And sometimes I suspect there's a geographic dimension to their criticism.

Economists and others who live in Canberra seem terribly confident they know better than the Reserve - much more confident than those living in Sydney, the same town as the Reserve. Indeed, the self-proclaimed superior understanding of the Canberrans is exceeded only by that of economists from Melbourne.

The Reserve is, of course, far from omniscient. Its forecasts are often astray. And these days, forecasting is more important than ever. In the old days, governments waited until they had hard statistical evidence inflation was getting out of hand before they took corrective action by raising interest rates.

Which meant they were almost always acting too late - sometimes so late they ended up making matters worse rather than better. That's because changes in rates have their effect on demand and then prices only after a "long and variable lag".

Since the Reserve attained its independence from the elected government, it has sought to correct for monetary policy's long "response lag" by conducting policy on a forward-looking basis, or "pre-emptively".

That is, policy decisions are based on forecasts for growth and, more particularly, inflation over the coming 18 months to two years. The arrival of actual figures is used just to adjust the forecasts.

And, as I say, the Reserve's forecasts are often astray. But this just reflects the limitations of the economics profession's art. The question is whether any of the Reserve's many second-guessers are any better at forecasting than it is. I remain to be convinced any are.

Although the Reserve's present course of action is always being criticised by someone - and not only the business lobby groups that make their living by always arguing rates should lower - I see little reason to believe they could do any better.

Indeed, they could easily do a lot worse. The Reserve makes a lot of small errors, but it's yet to make any really serious ones - the reason its critics have failed to gain much credibility.

One reason the Reserve never gets too far off beam is that it revises its forecasts every quarter and generally moves in tiny steps of 25 basis points (0.25 percentage points). And it's never too proud to change direction if it becomes obvious it should.

The other reason the Reserve has yet to get things badly wrong is that no one understands better than it how fallible its forecasts are - all forecasts, for that matter. And it's never afraid to admit its fallibility to the world.

Just as newspapers that regularly correct their errors are more trustworthy than those that rarely do, so those official forecasters who freely acknowledge their failings engender more confidence in their competence rather than less.

The Reserve revised its forecasts in the statement on monetary policy it issued on Friday. And for the first time it provided "confidence intervals" for its latest forecasts for growth and underlying inflation. These intervals were based on the range of the Reserve's actual forecast errors between 1993 and 2011.

It advised that a 70 per cent confidence interval for the forecast of underlying inflation over the year to the December quarter of 2014 extends from 1.6 per cent to 3.2 per cent. That is, if the Reserve makes similar-sized forecast errors to those made in the past, there is a 70 per cent probability that underlying inflation will lie between 1.6 per cent and 3.2 per cent.

Similarly, there's a 70 per cent probability that growth in real gross domestic product (GDP) over the year to the December quarter of 2014 will lie between 1.5 per cent and 4.4 per cent.

Hardly particularly informative? At least it avoids the illusion of certainty about what the future holds. But if your own fallibility makes you prefer a central, single-number forecast (a "point estimate"), you can use the fact that the confidence intervals are assumed to be symmetrical to work out what it is.

Add 1.6 to 3.2 and divide by two and the central forecast for underlying inflation is 2.4 per cent. Similarly, halving 1.5 plus 4.4 tells you the central forecast for growth is a fraction less that 3 per cent.

Happy now? If you're really keen you can apply a ruler to the confidence interval graphs in the statement and work out the Reserve's central forecast quarter by quarter - something it has never previously (sort of) made public. Whether it continues doing so has yet to be decided.

The width of the confidence interval (plus or minus 0.8 percentage points in the case of underlying inflation; plus or minus 1.5 points in the case of growth) indicates there is always substantial uncertainty about the economic outlook. (Though less about the more inertia-driven inflation than about growth.)

The Reserve says such high levels of uncertainty are also found in other countries and for both official and private forecasts. Similarly, it's typical (and hardly surprising) for the degree of uncertainty to increase the further into the future you're forecasting.

But if economic forecasts are so universally inaccurate, how come we hear so little about confidence intervals? It's partly because economists don't like advertising the considerable limitations of their art. They don't even like reminding themselves of their own fallibility.

But it's also because economists are selling their services and are very conscious of how much their customers value the illusion of certainty, which allows the customers to delude themselves they have more ability to control the future than they actually do.

Saturday, February 9, 2013

How demography is affecting us right now

WORKING out what's happening in the jobs market is trickier than you may think - and has just got trickier. On the face of it, this week's figures from the Bureau of Statistics are simple: they show employment grew by a bit more than 10,000 last month and the rate of unemployment was steady at 5.4 per cent.

But it's not that simple. The rate at which people of working age participated in the labour force (either by holding a job or actively seeking one) fell from 65.1 per cent to 65 per cent of the labour force.

At times like these, with the growth in employment slowing and the number of job vacancies falling, a decline in the participation rate is usually taken as a sign the number of ''discouraged jobseekers'' is rising. These are people who'd like to work but who, believing there are no jobs available, have stopped actively seeking one, meaning they're no longer counted as unemployed.

So, many economists would take the fall in the participation rate last month to mean the jobs market deteriorated despite the unchanged rate of unemployment.

But if we want to play this game we should really start two years ago, in January 2011, when (using the trend figures) the unemployment rate reached a low of 5 per cent. Since then it's risen only to 5.4 per cent, which doesn't seem much.

Over the same period, however, the ''part rate'' has fallen from a peak of 65.8 per cent to 65 per cent. Saul Eslake, of Bank of America Merrill Lynch, calculates that had this decline not occurred, all else being equal the unemployment rate in December last year would have been 6.6 per cent, not 5.4 per cent.

Fortunately, however, it's still not that simple. Heard of the ageing of the population? Whereas for decades it was pushing our participation rate up, it's now started pushing it down, meaning it's no longer safe to assume a fall is all the work of discouraged jobseekers.

This is an unfamiliar but important story, so settle back for a primer on demography.

We are living at a time in the world's long history when longevity is steadily rising (because of improvements in public health, increasing affluence and advances in medical science) but fertility is falling (because of improvements in contraception and rising affluence). A country's ''total fertility rate'' is the average number of children women are projected to bear over their lives.

As The Economist magazine has explained, when a country's fertility rate falls sharply, the children born before the fall become ''a sort of generational bulge surging through a society''.

In the case of the developed countries, the sharp and continuing fall in fertility was caused by the advent of the contraceptive pill, and the surging generation became known as the baby boomers. But something similar happened a few decades later in those developing countries that began developing rapidly. Access to contraception improved, girls became better educated and families decided to have fewer children.

A country in this situation enjoys a ''demographic dividend''. After a while, the earlier generation becomes old enough to be part of the labour force (they reach the age of 15) and this happens while old people are dying fairly early and fewer babies are being born.

So the country enjoys a big improvement in its ''dependency ratio'' - the ratio of people who are dependent on others for their living (because they are either too young or too old to work) to those of working age (which is often defined as everyone over 15, but for these purposes should be limited to those aged 15 to 64).

The decrease in the dependency ratio - that is, the increase in the number of potential workers relative to the number of people they have to support - is the demographic dividend. It means a country can grow faster and become richer (measured as income per person) - provided you can find jobs for all those who want to work.

The dividend continues for several decades and actually gets bigger as the bulge generation enters the ''prime working age'' of 25 to 54. It has helped keep our participation rate rising and made a significant contribution to Australia's rate of economic growth for the past 30 or 40 years.

Can you see where this story is heading? Eventually, the demographic dividend becomes a negative as the bulge generation continues to age and eventually starts retiring. As Dr David Gruen of Treasury put it last year, the tail-wind of the past becomes the head-wind of the future.

When a baby boomer stops working, the working population falls by one and the dependent population increases by one, meaning the bulge of baby boomers produces a rapid deterioration in the dependency ratio. It also means we should see a decline in the participation rate as more of the population moves from the age range where they're highly likely to be working to one where they're much less likely to be working.

The first baby boomers were born in 1946, which was 67 years ago. The last were born in 1964, which was 49 years ago.

So by now you'd expect to see the participation rate falling for reasons that are completely demographic and have nothing to do with the state of the economy and the jobs market.

Sorry, one more complication. We've known for some years that the trend to early retirement has reversed and more older workers are delaying their retirement or finding ways to keep working for a few days a week. In other words, some baby boomers aren't retiring as expected - maybe because they're not feeling old and tired or maybe because they haven't saved enough to allow them to retire in the comfort to which they've become accustomed.

Obviously, to the extent this is happening it's working to counter the purely demographic decline in the part rate. So what is happening?

The econocrats have done some figuring which shows that, over the year to December, ageing contributed minus 0.3 percentage points to the participation rate, while the trend to delay retirement contributed plus 0.1 percentage points.

In other words, the demographic dividend has reversed, although it's being partly offset by the trend of some baby boomers delaying their retirement.

So most but not all of the overall fall in the part rate can be regarded as a rise in hidden unemployment.

Wednesday, February 6, 2013

The four industries with most clout in Canberra

Like most, I believe in democracy. But I also believe in capitalism, and though the two have usually been seen in the West as a good fit, of late I'm having doubts.

Every society has to use some system for organising production and consumption, and I know of none better than leaving it largely to private enterprise.

For the most part, markets work well in bringing buyers and sellers together and satisfying their respective needs. Markets' reliance on people pursuing their own interests does a good job in encouraging efficiency and innovation.

The funny thing is, when capitalism is working well it's the capitalists themselves who get taken advantage of. They keep coming up with new ways of making a fortune - railways, electricity, motor cars, the telephone, radio, television, the internet - but in the end competition causes most of the start-up companies to go broke and leaves most of the benefit not with the capitalists but their customers. It comes in the form of access to affordable transport, power, entertainment or communication.

Of course, as the global financial crisis so painfully reminded us, markets are far from perfect and it's folly to leave them inadequately regulated. Markets are actually a creation of government, and governments have to continuously supervise them to ensure they don't run off the rails.

It's this need for continuous government involvement that can cause problems. Can we be sure government intervention is always aimed at benefiting customers rather than making life easier for the few big companies that dominate many of our markets?

Then there's democracy. What if it becomes too easy for capitalists to take advantage of the institutions of democracy to get the rules of the game bent in their favour? Of all the columns I wrote last year, the one that drew the biggest reaction was called ''The four business gangs that run America'', quoting a book by Professor Jeffery Sachs of Columbia University. Sachs wrote that four key sectors of US business exemplified the takeover of political power in America by the ''corporatocracy'': the military-industrial complex, the Wall Street-Washington complex, the Big Oil-transport-military complex and the healthcare industry.

I ended the column by saying that ''fortunately, things aren't nearly so bad in Australia''. It's true, they're not. But, in a paper to be issued on Wednesday, ''Corporate power in Australia,'' by Dr Richard Denniss and David Richardson, of the Australia Institute, we're reminded that things here are far from ideal.

The authors argue that ''big business exerts influence through campaign contributions, influence over university funding, sponsorship of think tanks and in other ways''.

The four most disproportionately influential industries in Australia, they say, are superannuation, banking, mining and gambling.

Employers in Australia are required by law to remove 9 per cent of employees' pre-tax wages and deposit it in a superannuation account the employees can't touch until they retire. The industry has now persuaded the Labor government to gradually increase this to 12 per cent.

Thus the government has compelled almost all employees to become the customers of a particular industry.

The average management fee paid by Australians with a retail super fund is about 2 per cent of their fund balance each year.

So someone with a balance of $100,000 is paying a fee of about $2000 a year, or nearly $40 a week. This is more than the average Australian pays for electricity. After the compulsory contribution rate is raised to 12 per cent, these annual fees will have increased by a third.

To be fair, the government is working to oblige the super industry to give its captive customers a better deal. But it is encountering - and yielding to - much push-back from the industry.

According to the authors, our big four banks are among the eight most profitable banks in the world, with the International Monetary Fund saying we have the world's most profitable banking system.

Over the years, the big four have been allowed to acquire or merge with 15 of their rivals, with the authorities continuing to insist the industry is competitive.

Since the global financial crisis, the big four's market share has risen from 74 per cent to 83 per cent, the authors say.

Both sides of politics profess to be highly disapproving when the banks seek to protect their profit margins by failing to pass on all of a cut in the official interest rate.

But the pollies rarely match their words with deeds. Their efforts to increase competition are quite timid and some measures actually make life easier for the banks.

Last year the mining industry accounted for more than a fifth of all the profit made in Australia, even though it had a much smaller share of the economy. This was mainly because the royalties charged by the state governments failed to capture enough of the market value of the minerals the largely foreign-owned miners were being permitted to extract.

When the Rudd government tried to correct this with a resource super profits tax, the industry set out to bring about its electoral defeat, Tony Abbott saw his chance and sided with the industry, and Julia Gillard backed off rapidly, settling for a new tax that seems to be raising little revenue.

Gambling is a small industry, but incredibly lucrative, partly because it's so tightly regulated. Whether it's the way the O'Farrell government is accommodating James Packer's ambition to expand in Sydney or the way Gillard welched on a written agreement with Andrew Wilkie under pressure from the licensed clubs, the industry's political power is apparent.

When politicians worry more about pleasing certain industries than about serving the people who elect them, we have a problem.


Monday, February 4, 2013

Why voters seen the economy as in bad shape

Despite last week's excitement, Julia Gillard's early announcement of the election date is unlikely to change much. It's certainly unlikely to change many voters' perceptions on a key election issue: her ability as an economic manager.

It's long been clear from polling that the electorate doesn't regard the government as good at managing the economy.

Why this should be so is a puzzle. As Gillard rightly claimed last week: "As the global economy still splutters, unlike the rest of the world we have managed our economy so we have low inflation, low interest rates, low unemployment, solid growth, strong public finances and a triple-A rating with a stable outlook from all three of the major ratings agencies."

I've said elsewhere that part of the reason for this yawning gap between perception and reality is that many people's perception of how well the economy's being managed proceeds not from independent observation but from their political alignment. Once I know who I'm voting for I then know whether or not the economy's travelling well.

But there's another part of the explanation: the public's inability to distinguish between cyclical and structural factors. Most of the bad news we heard last year was structural in nature, meaning it changed the shape of the economy rather than its overall size, adversely affecting some parts but favourably affecting others and having little effect on most.

But such analysis is too subtle for most punters. To them, all news is cyclical: good news means the economy's on the up and up; bad news means it's going down and downer.

Add the media's inevitable predilection for trumpeting bad news, underplaying good news and totally ignoring anything that doesn't change, and structural change can't help but be perceived as an economy in trouble.

The resources boom is the classic case of structural change. It's in the process of giving us a bigger mining sector and bigger non-tradeable services sector, but a relatively smaller manufacturing sector and internationally tradeable services sector.

The mechanism that brings much of this about is the high dollar. It harms all export- and import-competing industries, but benefits everyone who buys imports (which is all of us). It marginally benefits three-quarters of our industries, which are non-tradeable (they neither export nor compete against imports) but do buy imported supplies and equipment.

Now consider the recent performance of unemployment. Over the year to December, the unemployment rate rose from 5.2 to 5.4 per cent.

Admittedly, the rate at which people of working age were participating in the labour force by holding a job or actively seeking one fell from 65.3 to 65.1 per cent. This decline in participation is probably explained mainly by some people becoming discouraged in their search for a job.

Even so, it's surprising people became a lot more worried about unemployment last year. Why did they? Because they get their impressions about the state of the labour market not from the official statistics but from stories on the TV news about people being laid off from factories.

If voters were more economically literate they'd respond to this news by thinking, "Gosh, isn't manufacturing being hit hard by the high dollar - but fortunately I don't work in manufacturing and only 8 per cent of workers do." What many actually thought was: "Gosh, maybe I could lose my job, too."

Thus was a structural problem affecting only a small part of the economy taken to be a cyclical, economy-wide problem.

It's a similar story with the much-publicised tribulations of the retailers, which arise from their need to adjust to various structural problems, such as the inevitable end to the period in which household spending grew faster than household income, and the rise of internet shopping.

With all the silly talk about "the cautious consumer" and with punters blissfully unaware that retailing accounts for only about a third of consumer spending, all the highly publicised complaints of the Gerry Harveys helped convince the public not that the retailers have their own troubles but that the economy must be going down the tube.

Then there's the contribution of the unending fuss about "debt and deficit", in which the government has been completely outfoxed by the Liberals.

Although every economically literate person knows Australia doesn't have a significant level of public debt, the opposition has had great success exploiting the public's ignorance of public finance and of just how big the economy is ($1.5 trillion a year) by quoting seemingly mind-boggling levels of gross public debt.

With much of this argy bargy being reported by political rather than economic journalists - how many times have you heard talk of "the economy's deficit"? - it's hardly surprising the public has acquired an exaggerated impression of the economic significance of the budget deficit.

Ironically, the budget deficit is a case where a cyclical (temporary) problem has been taken to be a structural (long-lasting) one.

But Labor has to accept much of the blame for this bum rap. Rather than standing up to the nonsense the Libs were talking, it took the path of least resistance, purporting to be just as manic as they were. Then came Gillard's foolhardy decision to take a mere Treasury projection of the budget outcome in three years' time and elevate it to the status of a solemn promise.

By now, the voters' majority perception that the economy's in bad shape and Labor isn't good at managing it is deeply ingrained.

Saturday, February 2, 2013

Gillard talks tough in election year

THIS is shaping up as an unusual election year - and not because Julia Gillard has announced the election's date eight months in advance. With luck it won't be the trip to fantasyland the politicians on both sides usually take us on, in which they pretend to be able to solve all our problems without pain and we suspend disbelief.

Predictably, Gillard's unprecedented step in naming the date in her speech to the National Press Club on Wednesday almost totally diverted the media's attention from everything else she said. This is a pity because the rest is worthy of note. It was a lot more honest than you'd expect to hear from our politicians in an election year.

On our overblown whinges about the cost of living, Gillard was braver than this government has been before. Try this: ''The price we pay for electricity and gas has increased by 120 per cent in the last decade and 26 per cent in the last two years.

''Despite low inflation and low interest rates, we still feel these pressures on living standards.'' A subtle way of reminding people to put their one legitimate complaint (which it took Labor far too long to challenge) into the context of low price rises generally.

Here's something more sophisticated: ''Superannuation returns are only just beginning to recover from the hit delivered by the global financial crisis. Capital city housing prices have not grown at all in the past 12 to 18 months, compared to the average yearly gains of 8 to 10 per cent in the years before the GFC.

''These two impacts have us worried that our dreams of financial security are harder to achieve than ever before. Today, we save over 10 per cent of household income. In the years before the GFC, we used to save nothing as a nation.'' (She means Australian households as a whole saved nothing. Add in the public and corporate sectors and the nation saved a lot.)

But here's the stab of reality: ''It was a phase that could not last.''

Indeed it couldn't.

Next, some frank talk about the strong dollar. Our dollar has appreciated about 60 per cent in the past three years, she said. This presented a challenge to our economic diversity and international price competitiveness.

So what's the answer? ''Economic orthodoxy prescribes that falling terms of trade [the prices of exports relative to the prices of imports] and falling interest rates will result in a fall in the value of a currency.

''But even though our terms of trade peaked around 15 months ago and interest rates have been falling, our dollar is now actually higher.''

And ''over the coming year or two we expect to move beyond the peak of the investment phase of the mining boom''. (I expect it to come sooner than that.) ''Ordinarily, economists would tell you this change, bringing with it a lessening of demand for [foreign] capital, would be associated with a reduction in the Australian dollar that would assist export-exposed industries like manufacturing, tourism and [other] services that are exported, like education.

''However, just as the dollar's strength has persisted in this period of declining terms of trade and interest rates, we need to be prepared if it persists despite a lessening of demand for [inflows of financial] capital.''

It's all true. The sad fact is, economists do not have a good handle on what drives a country's exchange rate.

What's more, ''we cannot control a number of factors that have kept our dollar strong: like the weakness in the global economy, the close-to-zero interest rates of many nations and the increasing view that Australia is something of a safe haven''.

Good point. Remember, the exchange rate is a relative price. Our economic prospects may not be brilliant, but as long as they're better than for the other developed countries our currency may well stay stronger than theirs.

So Gillard isn't promising or predicting any marked decline in the dollar. She's warning our export and import-competing industries to adapt to a higher-than-comfortable exchange rate.

''Where we can make a difference is to other factors that matter for competitiveness and economic diversity. So we can and must focus on increasing skills, building a national culture of innovation, rolling out the national broadband network, investing in infrastructure, improving regulation and leveraging our proximity to, and knowledge of, a rising Asia into a competitive advantage.'' (I fear we're spending far more than we should on broadband.)

Next, a frank reminder of how skint the government is (and will be) because the recovery in the economy since the mild recession of 2009 hasn't led to the usual strength of recovery in tax collections.

''Revenue to government for every [dollar] of gross domestic product has been at its lowest since the recession of the early 1990s. In other words, for a given amount of economic income generated, less money is finishing in the public purse, to be used for the Australian people.''

Though the government has stuck to its medium-term fiscal strategy and spending is tightly constrained, she said, the amount collected from all sources - but particularly from company tax - is significantly lower than economists forecast.

This was part of a trend being felt worldwide and involves both domestic and global factors. ''The domestic factors include our nation being in the investment phase of the mining boom, not its peak production phase; the new saving and consumption approach of families; the slowdown in capital gains and the lack of profitability of many firms in trade-exposed areas due to the high dollar.''

Some of these factors were cyclical (temporary) and some would be longer lived.

Now for the election-year punch line: ''With pressure on revenue, it is the wrong time to be spending without outlining long-term savings strategies which show what will be forgone [not foregone, Julia] in order to fund the new expenditure.''

Gillard confirmed her intention to spend big on disability and school education. ''In the lead-up to and in the budget we will announce substantial new structural savings that will maintain the stability of the budget and make room for key Labor priorities.''

In a pre-election budget?

That will be new.

Wednesday, January 30, 2013

Outlook for economy not bright

As far as the economy's concerned, 2013 will be the year when many people's dreams come true. For at least the past two years, many of us - business people and consumers alike - have been convinced the economy is slowing and generally in bad shape.

Trouble is, until recently the hard statistics on the state of the economy have persistently refused to confirm this pessimism.

But now there's good news for the fearful. The nation's economists are as agreed as they ever get that this year the economy will slow, with the rate of unemployment likely to rise towards 6 per cent. Gloomy news will abound. Yippee.

The problem is that the great surge of investment in the construction of new mines and natural gas facilities seems close to its peak. It is unlikely to fall away dramatically, but it should at least reach a plateau and may fall back a little.

All these years of expanding our production capacity is now producing growth in the quantity of our exports of mineral and energy but, at present, this won't be sufficient to replace the impetus we have been getting from the growth in spending on new mines.

And the rest of the economy is not likely to be growing fast enough to fill the vacuum. Business confidence has been poor for some time and, apart from mining, business investment in expansion has been weak and is expected to stay weak.

Normally, a fair bit of the economy's growth comes from the building of new homes, in line with the growth in the population. But in recent years the housing sector has been surprisingly weak. We haven't had as much building of new homes as usual, nor renovation of existing homes, nor buying and selling of existing homes.

Just why housing has been weak for so long is hard to know. It hasn't been a lack of population growth. But the absence of steadily rising house prices is both a consequence and a cause of the weakness.

Housing activity is at last starting to pick up, but it is unlikely to be particularly strong this year.

Next in this tour of the dark side is what many business people regard as the clincher: lack of consumer confidence. Consumers are going through a period of great caution, we have been told repeatedly, and so aren't spending much.

One small problem: so far this hasn't been true. It is true consumer confidence has been surprisingly weak, but it is not true this has led to weak growth in consumer spending. It is also true households are saving a much higher proportion of their incomes than they did for many years.

But the rate of household saving has been steady for several years, meaning consumer spending has been growing at the same rate as household disposable incomes. And since household income has grown reasonably strongly, so has consumer spending.

So how do we account for the tales of woe from retailers? It is simple. Contrary to popular impression, only about a third of all the money consumers spend is spent in the shops of retailers. The retailers have been doing it tough because the share of the consumer dollar going to them has been declining.

With the dollar so high, imports have been cheaper and we have been spending a lot more on overseas holidays and imported cars. To a small but growing extent, our retailers have suffered as we are using the internet to access the cheaper prices charged abroad. And with fewer new homes being built and fewer people moving homes, fewer of us have been buying new furniture and furnishings.

What interests me, however, is why the gloom of so many business people and consumers has so far greatly exceeded the reality. Why people's perceptions of the state of the economy have been so much worse than what the hard facts tell us.

It may be that people have attached too much local significance to all the gloomy news we have been hearing from abroad about troubles with the euro and the Americans' fiscal cliff, but I believe a big part of the explanation is political.

Many business people seem to be sitting on their hands until the political atmospherics improve. They say the period of minority government has damaged confidence, but this is code for their impatience to see the back of Julia Gillard.

At least with business people their measured lack of confidence accords with their reluctance to invest in expanding their businesses. With consumers, the standard measure of their confidence compiled by Westpac and the Melbourne Institute has proved an unreliable guide to their actual behaviour.

If you delve into that index you discover that people intending to vote Liberal are far more pessimistic about the economy than those intending to vote Labor. I suspect it will prove a better indicator of who will win this year's election than of the prospects for consumer spending.

Another part of the explanation for the discrepancy between perception and reality is surely that the tribulations of certain industries - notably manufacturing and retail - have mistakenly been taken as symptomatic of the whole economy.

But not to worry. The economists assure us 2013 will be the year when reality finally aligns with our negative perceptions. Not being a pessimist myself, however, I see two grounds for hope.

One is that if all the economists are sure the economy will slow, there must be a good chance they are wrong yet again.

And remember the light at the end of the tunnel: come the election, God will be back in his Liberal heaven and all will be right with the world.

Monday, December 31, 2012

The four business gangs that run America

IF YOU'VE ever suspected politics is increasingly being run in the interests of big business, I have news: Jeffrey Sachs, a highly respected economist from Columbia University, agrees with you - at least in respect of the United States.

In his book, The Price of Civilisation, he says the US economy is caught in a feedback loop. "Corporate wealth translates into political power through campaign financing, corporate lobbying and the revolving door of jobs between government and industry; and political power translates into further wealth through tax cuts, deregulation and sweetheart contracts between government and industry. Wealth begets power, and power begets wealth," he says.

Sachs says four key sectors of US business exemplify this feedback loop and the takeover of political power in America by the "corporatocracy".

First is the well-known military-industrial complex. "As [President] Eisenhower famously warned in his farewell address in January 1961, the linkage of the military and private industry created a political power so pervasive that America has been condemned to militarisation, useless wars and fiscal waste on a scale of many tens of trillions of dollars since then," he says.

Second is the Wall Street-Washington complex, which has steered the financial system towards control by a few politically powerful Wall Street firms, notably Goldman Sachs, JPMorgan Chase, Citigroup, Morgan Stanley and a handful of other financial firms.

These days, almost every US Treasury secretary - Republican or Democrat - comes from Wall Street and goes back there when his term ends. The close ties between Wall Street and Washington "paved the way for the 2008 financial crisis and the mega-bailouts that followed, through reckless deregulation followed by an almost complete lack of oversight by government".

Third is the Big Oil-transport-military complex, which has put the US on the trajectory of heavy oil-imports dependence and a deepening military trap in the Middle East, he says.

"Since the days of John D. Rockefeller and the Standard Oil Trust a century ago, Big Oil has loomed large in American politics and foreign policy. Big Oil teamed up with the automobile industry to steer America away from mass transit and towards gas-guzzling vehicles driving on a nationally financed highway system."

Big Oil has consistently and successfully fought the intrusion of competition from non-oil energy sources, including nuclear, wind and solar power.

It has been at the side of the Pentagon in making sure that America defends the sea-lanes to the Persian Gulf, in effect ensuring a $US100 billion-plus annual subsidy for a fuel that is otherwise dangerous for national security, Sachs says.

"And Big Oil has played a notorious role in the fight to keep climate change off the US agenda. Exxon-Mobil, Koch Industries and others in the sector have underwritten a generation of anti-scientific propaganda to confuse the American people."

Fourth is the healthcare industry, America's largest industry, absorbing no less than 17 per cent of US gross domestic product.

"The key to understanding this sector is to note that the government partners with industry to reimburse costs with little systematic oversight and control," Sachs says. "Pharmaceutical firms set sky-high prices protected by patent rights; Medicare [for the aged] and Medicaid [for the poor] and private insurers reimburse doctors and hospitals on a cost-plus basis; and the American Medical Association restricts the supply of new doctors through the control of placements at medical schools.

"The result of this pseudo-market system is sky-high costs, large profits for the private healthcare sector, and no political will to reform."

Now do you see why the industry put so much effort into persuading America's punters that Obamacare was rank socialism? They didn't succeed in blocking it, but the compromised program doesn't do enough to stop the US being the last rich country in the world without universal healthcare.

It's worth noting that, despite its front-running cost, America's healthcare system doesn't leave Americans with particularly good health - not as good as ours, for instance. This conundrum is easily explained: America has the highest-paid doctors.

Sachs says the main thing to remember about the corporatocracy is that it looks after its own. "There is absolutely no economic crisis in corporate America.

"Consider the pulse of the corporate sector as opposed to the pulse of the employees working in it: corporate profits in 2010 were at an all-time high, chief executive salaries in 2010 rebounded strongly from the financial crisis, Wall Street compensation in 2010 was at an all-time high, several Wall Street firms paid civil penalties for financial abuses, but no senior banker faced any criminal charges, and there were no adverse regulatory measures that would lead to a loss of profits in finance, health care, military supplies and energy," he says.

The 30-year achievement of the corporatocracy has been the creation of America's rich and super-rich classes, he says. And we can now see their tools of trade.

"It began with globalisation, which pushed up capital income while pushing down wages. These changes were magnified by the tax cuts at the top, which left more take-home pay and the ability to accumulate greater wealth through higher net-of-tax returns to saving."

Chief executives then helped themselves to their own slice of the corporate sector ownership through outlandish awards of stock options by friendly and often handpicked compensation committees, while the Securities and Exchange Commission looked the other way. It's not all that hard to do when both political parties are standing in line to do your bidding, Sachs concludes.

Fortunately, things aren't nearly so bad in Australia. But it will require vigilance to stop them sliding further in that direction.

Saturday, December 29, 2012

Behavioural economists smarten up government

SINCE it's the summer hols, let me ask you a few personal questions. Do you sometimes fail to read every word of the official letters you get? Do you put off filling in forms or delay paying parking fines or taxes? Are you ever less than scrupulously honest on government forms?

If so, I have news: the economists are on to you. Actually, it's the behavioural economists, and their thing isn't to punish you but just make it easier for you to be a good boy or girl.

Behavioural economics is particularly suited to politics and public policy because it's the study of how people make decisions in real life, not how they'd behave if only they were "rational", which they aren't.

When David Cameron became Prime Minister of Britain he did something new, setting up a "behavioural insights team" within his cabinet office. Its job was to apply the insights of behavioural economics (most of which come from psychology) to government operations and see if they improved things.

The team decided to start with the related problems of fraud (people claiming benefits they aren't entitled to), error (people inadvertently giving wrong information) and debt (people not paying what they owe the government).

Earlier this year the team issued a report on how it was getting on. It estimated fraud was costing British taxpayers about $14 billion a year. Error was costing $6 billion and unpaid debt up to $5 billion a year.

Traditional attempts to combat fraud, error and debt have tended to assume people rationally weigh up the personal costs and benefits of non-compliance by comparing the amount they expect to gain with the probability of being caught and the size of the punishment.

The usual approach seeks to increase compliance either by increasing the penalties or increasing the chance of being caught.

But humans don't behave like that. The vast majority of people don't commit fraud or avoid paying debts. And they don't because they have a strong sense of moral obligation, justice and fairness, which is shared by those around them.

So maybe you can reduce non-compliance by finding ways to reinforce such social norms. And maybe people give wrong information or end up doing the wrong thing for much less sinister reasons of mere human fallibility.

After scouring the academic literature, the team has come up with seven insights that should help increase compliance, which it is now testing using randomised controlled trials.

The seven have one thing in common: rather than ordering people to do things they don't like doing, they seek to go with the grain of how people behave.

Insight one is: make it easy. Make it as straightforward as possible for people to pay tax or debts. For instance, you can spell out in order the steps people need to take to do what's required of them.

Or you can make it easier for people to submit a tax return by pre-filling the form with information the government already knows. With computers and online forms, this is now much easier to do - as our Tax Office has shown. It also reduces error.

Insight two is: highlight key messages. Draw people's attention to important information or actions required of them, for example, by highlighting them upfront in a letter.

Eye-tracking research suggests people generally focus on headings, boxes and images, while detailed text is often ignored, the report says. The front pages of letters receive nearly 2? times the attention back pages do.

Britain's Inland Revenue has a program offering doctors an opportunity to bring their outstanding tax payments up to date before official action and penalties. When it compared its usual letter with a simplified version using plain language, key messages and required actions highlighted at the top of the letter, the response rate jumped from 21 per cent to more than 35 per cent.

Insight three: use personal language. Personalise language so people understand why a message or process is relevant to them. New technology is making it easier and cheaper to address mass mail-outs to people by name. Giving people a name and number to contact may get a better response than pointing to a general helpline.

Sometimes Inland Revenue needs people to contact it to arrange repayment of tax credits they weren't entitled to. It's been trialling different versions of the letter it sends. People in the control group were sent a letter simply stating the phone number to call, and 13 per cent responded. Others were sent a letter framed as a personal message urging them not to overlook the opportunity to get in touch. That one had a response rate of 24 per cent.

Insight four: prompt honesty at key moments. Ensure people are prompted to be honest at the start of forms rather than the end.

Most people are honest most of the time. Most people, rightly, think of themselves as honest, the report says. And, because we have an inherent desire to be consistent with our self-image, well-placed reminders should encourage greater honesty, the report says.

Insight five: tell people what others are doing. To take advantage of and reinforce social norms, highlight the positive behaviour of others. Provided it's true, for instance, tell people that "nine out of 10 people pay their tax on time". This can correct mistaken perceptions.

Inland Revenue experimented with letters designed to get people to increase their tax debt payments. Compared with the control letter, those quoting the national social norm produced a 5 percentage-point improvement in the response, those quoting the social norm in your postcode got an improvement of more than 11 points and those quoting the norm for your town produced an improvement of more than 15 points.

Insight six: reward desired behaviour. Actively incentivise behaviour that saves time or money. Sometimes just saying thank you helps. Or you can put people's names in a prize draw. Rewarding good behaviour may work better than punishing bad behaviour. But be careful the use of rewards doesn't crowd out intrinsic motivation - doing the right thing because it's the right thing to do.

Finally, insight seven: highlight the risk and impact of dishonesty. Emphasise the risk of getting caught, but also the consequences of my dishonesty for the welfare of others.

You think economists give airy-fairy, impractical advice to governments? Not the new breed of behavioural economists.

Wednesday, December 26, 2012

Exertion, not avoiding it, makes us happy

Forgive me for saying so, but don't you think you'd be better off going for a run - or even a brisk walk - than reaching for another mince pie? (The ones my wife made this year were irresistible.)

Chances are you don't think it. Or maybe you think it, but you don't intend to act on it. If you can't take a day off on Boxing Day, when can you?

I hate to say it, but humans have a slothful streak. We want to live comfortable, enjoyable lives and we assume the less physical effort this involves the better. But one of the most unremarked and remarkable discoveries of our times is that it doesn't work like that.

As a writer about economics, I suppose I'm required to be an advocate of progress. But I'm learning progress can be a tricky beast. Sometimes it involves moving away from the practices of the past as far and as quickly as possible. But occasionally we discover we need to retrace our steps.

A major element of humankind's progress - of our civilisation - has been our unrelenting efforts to take the effort out of all we're required to do to live our lives. That story begins with our discovery of first stone, then metal tools. It progresses to our discovery that settling in one spot and farming crops and animals was a lot safer, more comfortable and prosperity-inducing than hunting and gathering.

Fast forward to the industrial revolution, which began in the second half of the 18th century. It, too, was fundamentally about taking the physical effort out of work, first with the discovery of steam power, then later, electricity and the internal combustion engine - all of them powered by the burning of fossil fuels.

Along the way we invented a multitude of ways to mechanise work - from the spinning jenny to the typewriter - thereby greatly reducing the number of workers needed to produce a given quantity of goods and services or, looking at it another way, allowing a given number of workers to produce a much greater quantity of goods and services.

Whichever way you look at it, our unceasing search for new and better ''labour-saving'' devices has greatly increased the productivity of our labour - the quantity of goods and services the average worker is able to produce in an hour - and this explains why our material standard of living is many times higher than it was at the time of white settlement in Australia.

Usually, this is what economists portray as the object of this grand exercise, making ourselves richer. But it's equally true that a central element of the exercise has involved taking the physical exertion out of work. We haven't ended up doing a lot less work than we used to, but our work has become much less physical and much more mental, requiring us to be a lot better educated and trained.

More recently - and particularly with the advent of the information revolution - we've moved from taking the physical effort out of work to also taking it out of leisure. We drive when we could walk or ride around our suburbs at the weekend. For home entertainment we no longer sing or recite to each other, but turn on some electronic device. And the commercialisation of sport means not only that we watch professionals rather than playing ourselves, but needn't even leave the house to watch a game.

This is where we've overreached, however. This is where nature is striking back. Combine the way machine-produced food has never been more enticing, more plentiful or as cheap with the success of our efforts to strip physical exertion from work and leisure, and you get an obesity epidemic.

And it's not just that. As each year passes the medicos uncover ever more evidence of the many ways our lack of exercise is contributing to our ill-health, including heart disease, type II diabetes, high blood pressure, cancer, depression and anxiety, arthritis and osteoporosis.

To put it more positively, and to borrow a slogan from the American College of Sports Medicine, exercise is medicine. This is what I find so remarkable, so surprising.

Recent research by medicos in Texas has found that previously sedentary women who began moderate aerobic exercise a third of the way into their pregnancy had significantly fewer caesarean deliveries and recovered faster after the birth.

Research by Dick Telford and colleagues at the Australian National University has found that primary school children who are more physically active and leaner get better academic results and, even more so, that primary schools with fitter children achieve better literacy and numeracy.

Research quoted on the Exercise is Medicine website says active people in their 80s have a lower risk of death than inactive people in their 60s.

Regular physical activity can reduce the risk of recurrent breast cancer by about half, lower the risk of colon cancer by more than 60 per cent, reduce the risk of Alzheimer's, heart disease and high blood pressure by about 40 per cent and lower the risk of stroke by 27 per cent. It can decrease depression as effectively as Prozac or behavioural therapy.

According to the site, a low level of fitness is a bigger risk factor for mortality than mild-to-moderate obesity. And regular physical activity has been shown to lead to higher university entrance scores.

But here's the bit I like best (and know from experience is true): research shows that exercise makes you feel better, reducing stress, helping you sleep better and feel more energetic. The unexpected truth is that it's exertion, not the avoidance of it, which makes you happy.

Monday, December 24, 2012

Workers attacked because of economy's success

THE most despicable behaviour of 2012 must surely be the return of big business people trying to make Australia's employees feel guilty about their high wage rates. Chief executives aren't overpaid but ordinary workers are? Yeah, sure.

It makes you wonder whether our business people are knaves or fools: are they knowingly talking nonsense or are they simply economically illiterate?

I'm genuinely not sure. I realised long ago it's possible to be a highly successful business person and yet not know enough to pass a high school economics exam. I could name names, but I won't.

Of course, business people would be perfectly justified in arguing the reverse: it's possible to be the most learned economist in the country yet be a total dud as a manager.

All this proves is that, contrary to popular impression, economics and business management are separate skills. The macro economy is not just a company writ large.

Chief offenders among the big business people saying stupid things about wage rates are the miners. In seeking to explain why the fall in coal and iron ore prices from sky-high to merely unusually high has prompted them to start cancelling projects for new mines, they complain that Australia has become a "high-cost" place to do business.

In part this is an unjustified whinge about the mining tax; in part it's a complaint about the continuing high dollar. The miners are justified in reminding us that all export and import-competing industries are adversely affected by a high exchange rate, including them.

For the most part, however, it's a complaint about the way wage rates for mine and construction workers have shot up in recent years. Remember, the West Australian miners were in the vanguard of those using John Howard's WorkChoices to force their workers on to individual contracts and get rid of (admittedly, often unreasonable) unions.

It's been the miners leading the campaign by business and the national dailies to reverse the direction of Fair Work and bring back individual contracts. So, the miners want us to believe it's the Fair Work Australia changes and the power they put back into the hands of the unions that explain the rapid rate at which the miners' wage bill has been growing.

If you believe that, you know nothing about economics, starting with the laws of supply and demand. What we've had in Western Australia - and Queensland - is a host of miners, big and small, desperate to expand their existing mines and build new ones and get the projects finished while world prices stay high.

So, you've got a sudden surge in demand for labour in remote and inhospitable parts of the country where few workers live, coming from companies that have never put much effort into training their own young workers.

Demand for labour has shot way ahead of supply as miners race their competitors to get their projects under way. What happens in any market when demand runs ahead of supply? The price goes up. One of the things the higher price does is attract resources from other parts of the economy.

If there are unions present, they will use their improved bargaining power to extract big pay rises from employers anxious just to get on with it. If there are no unions present, much the same thing happens as employers try to outbid their local rivals and also suck in labour from other states.

Only an economic ignoramus could imagine wages wouldn't have risen in the absence of unions.

But there's nothing new about the tactic of trying to make Australian workers believe there's something illegitimate about the high wages they're paid. In the protectionist era it was a favourite tactic of manufacturers demanding higher tariffs on imports.

Their argument was that, if workers in Asian sweatshops were getting $2 an hour and ours were getting $15, ours were being overpaid by $13 an hour. If that makes sense to you, go to the bottom of the economics class.

The first point is that the cost of labour is just part of the total cost of any product, though it's true that labour costs are the biggest element in the prices of simple, labour-intensive items such as textiles, clothing and footwear.

Countries such as Germany and Sweden have very high hourly wage costs, yet manage to hold their own in international markets for sophisticated manufactures. How? By compensating for high wage costs by having much better-trained workers, better capital equipment, longer production runs, smarter managers, higher quality, better service or other non-price selling points.

More fundamentally, it's possible but not common for the general level of a country's wages to be too high because the union movement has too much power. A rich country's wage rates are very high - way higher than a poor country's rates - because a country's wage rates invariably reflect that country's material standard of living (income per person).

And, as a general rule, what determines a country's standard of living is the level of (as opposed to the annual rate of improvement in) its labour productivity.

How does a country achieve the high level of productivity that eminently justifies the high incomes its people are paid? By investing in good infrastructure, in the education and training of its workers and in the latest capital equipment, then ensuring its business and political leaders are highly capable.

One test of its political leaders is whether they let lazy business people and self-centred unions con them into making the country's consumers or taxpayers subsidise the continued existence of businesses unable to find a way to compete on the international market.

Saturday, December 22, 2012

Adding the environment to the national accounts

Over the eight years to 2010-11, gross domestic product increased by 28 per cent, whereas Australia's net energy use increased by 18 per cent. So our "energy intensity" - energy used per $1 of GDP - is falling at the rate of 1 per cent a year.

In 2010-11 we produced 89 per cent of our total energy supply domestically, with the remaining 11 per cent being mainly imported oil. This took our total annual supply of energy to almost 19,000 petajoules. Of this we exported 71 per cent - mainly coal, uranium and natural gas.

Turning from energy to water, the price charged to households rose by 17 per cent in 2010-11, while the amount of water consumed by households fell by 8 per cent. On average, households were paying $2.44 a kilolitre. Of total water consumption of more than 13,000 gigalitres, 54 per cent went to agriculture and 33 per cent to the rest of industry, leaving just 13 per cent going to households.

Turning from water to land, Victoria's 23 million hectares of rateable land are valued at more than $1 trillion. Residential land accounts for 83 per cent of this total value, even though it accounts for only 5 per cent of the state's total area.

How do I know all this? Because I've been reading the "energy account", the "water account" and the "land account (Victoria, experimental estimates)", each published by the Bureau of Statistics in the past few weeks.

You may think from the examples I've given that the sort of information contained in these "accounts" is mildly interesting. But this exercise is really important and, to those of us who worry about the ecological sustainability of economic activity, even exciting.

You've seen me bang on before about the need for us to stop thinking of the economy being in one box and the environment in a completely separate box. The economy can't sensibly be separated from the environment because it exists within the natural environment - the ecosystem, if you prefer.

The economy depends on the ecosystem for its continued existence. It draws renewable and non-renewable natural resources and "ecosystem services" (such as photosynthesis and other natural processes) from the natural environment, then pumps all manner of pollution and waste back into the ecosystem.

It's clear that if our neglect of the ecosystem as we run the economy causes damage or depletion to the ecosystem, a point could be reached where the malfunctioning of the ecosystem inflicts damage and loss back on the economy. We could get into an adverse feedback loop between the economy and the environment.

This, of course, is exactly what's worrying us about climate change. The extensive burning of fossil fuels is causing emissions of carbon dioxide and other gasses which, partly because the clearing of land has reduced the role of forests as carbon sinks, are building up in the atmosphere, trapping in heat and interfering with the world's climate.

I fear climate change is just the first and most pressing instance of adverse feedback between the economy and the environment. If so, we need to become a lot more conscious of the interaction between the two.

But how did we get into the habit of thinking of the economy in isolation from the environment? The rest of us fell into the habit because that's the way the economists have always thought of it.

In the second half of the 19th century, when economists were setting in concrete their way of conceptualising the economy and analysing its workings, it made sense for them to conclude the environment could be excluded from the model without any great loss of relevance.

At the time, global economic activity was quite small relative to the vastness of the natural world. They couldn't know how hugely economic activity would grow, with a rapidly multiplying global population and an ever-rising worldwide average material standard of living.

Nor could they know how damming rivers, irrigating crops and sinking bores would interfere with the water cycle, how clearing land, running farm animals and growing crops would interfere with soil quality, or how ever-improving fishing technology would almost denude our oceans of fish.

Another problem was that their model was built on the role of market prices in co-ordinating economic activity. Many aspects of the natural environment, vital though they were to the functioning of the economy, weren't privately owned and didn't have a market price, so were "external" to the model.

Yet another part of the reason we've fallen into the habit of ignoring the environment when we think about the economy is that this is the way we've constructed our economic indicators - our gauges of how it's travelling. The chief gauge is the "national accounts" with their bottom line, gross domestic product.

We've taken to sharing the macro-economists' obsession with GDP, a measure of market production of goods and services during a period and the income generated by that production. It's a good indicator of employment prospects, but it takes no account of the using up of natural resources, nor of the cost of the damage economic activity is doing to the ecosystem.

But though economists may be stuck in their ways, the world's national statisticians aren't so hidebound. The concepts, classifications and accounting rules needed to calculate the national accounts in member countries have long been set down by the United Nations Statistical Commission. Earlier this year the commission decided to introduce a system of integrated environmental and economic accounting. This will involve developing environmental accounts on a comparable basis to the existing economic accounts, so they can be combined to give a more comprehensive picture of how the economy is affecting the environment and the environment is affecting the economy.

This "system of environmental-economic accounting" - SEEA - is a huge project, involving the measurement of various environmental dimensions not presently measured and the conversion of physical measures - such as petajoules and gigalitres - into dollar values.

Our Bureau of Statistics is at the forefront of this international development. Its recently published energy, water and land accounts are stepping stones in this great advance.

Publishing integrated economic and environmental accounts won't magically solve all our environmental problems, but it will make it much harder to forget these two aspects of our existence are inextricably joined.