Economic problems the pollies don't notice

Whoever wins the looming election will inherit a quite uncertain outlook, in which the economy may well slow further and unemployment rise faster over the next few years.

If so, all the politicians' wrangling over "debt and deficit" will be of little relevance and no help. That's the conclusion I drew from Reserve Bank governor Glenn Stevens' surprisingly sombre speech this week, in which he switched from glass half-full to glass half-empty.

If you didn't get that message, it's probably because it was missed in the financial markets' usual obsession with looking for hints about the next move in interest rates and the media's obsession with searching for criticism of the politicians - real or imagined.

Stevens warned that, in our efforts to get economic growth back to its trend rate of about 3 per cent a year - which is necessary to stop unemployment continuing to worsen - "the challenges ahead are substantial". What's more, those challenges will continue for "the next few years".

His speech explained those challenges. You know the basic problem: ensuring the rest of the economy takes up the slack as the stimulus from the mining investment boom tails off.

The first uncertainty is the future path of mining investment spending, which "rose from an average of about 2 per cent of gross domestic product, where it had spent most of the previous 50 years, to peak at about 8 per cent".

Presumably, that means it could eventually fall by a massive 6 per cent of GDP. But over what period? We don't know. All Stevens knows is that "that big rise is now over, and a fall is in prospect, with uncertain timing. It could be quite a big fall in due course."

Spending on the construction of new mines and facilities could stay on a plateau for a while, or it could just keep falling. If it plateaus, it makes no contribution to growth; when it falls, it subtracts from growth.

Meanwhile, what have we got going for us on the upside? Stevens advises that, "at this stage, global growth is sub-par". So, not much help from the rest of the world.

The much awaited fall in the dollar has improved the price competitiveness of our trade-exposed industries, which should allow them to produce more. "It would not be a major surprise if a further decline occurred over time," he says, "though, of course, events elsewhere in the world will also have a bearing on that particular price".

In particular, how soon and how far the Aussie falls will be influenced by how much more "quantitative easing" (creation of money) we see in the developed economies, particularly the US.

And then, of course, there's the stimulus to the non-mining economy from the easing in monetary policy. Since late 2011, the Reserve has cut the official interest rate by 2 percentage points to 2.75 per cent (with another click likely on Tuesday).

So monetary policy is "very accommodative," Stevens tells us, "by historical metrics, at least".

Huh? It turns out that, in our present circumstances, low interest rates don't pack the punch they used to, so we're not going to get as much increase in activity as usual.

Why not? Because, Stevens reminds us, we're not just coping with the aftermath of one boom, but two. The other is the end of the "credit boom".

You'd expect unusually low interest rates to encourage increased spending, particularly on those things that are usually bought on credit: consumer durables, homes and (non-mining) business investment.

But Stevens warns that while "some strengthening in consumption from recent rather subdued growth rates is a reasonable expectation ... we should not expect a return to the sorts of growth seen in the 1995 to 2007 period".

Why not? Because that period, in which consumer spending grew much faster than household income, was a product of the housing credit boom that largely preceded the resources boom. Households borrowed heavily to buy homes, thereby pushing up household debt levels and the prices of homes.

Ever-rising house prices (but also rising share prices) left households feeling ever wealthier, encouraging them to reduce their rate of saving and thus to allow their consumption to grow faster than their income.

In the aftermath of the credit boom - when share prices fell a lot and house prices fell a bit - households felt poorer and became more concerned about their high levels of debt. They thus began increasing their saving and trying to reduce their debts.

The household saving rate has now been steady at about 10 per cent of household disposable income for several years, meaning consumer spending has grown (and, as a matter of arithmetic, could only grow) at the same rate as household income.

Some people think the rate of household saving is unusually high and is the product of low consumer confidence, meaning it should fall when consumers cheer up, causing - again as a matter of arithmetic (because income equals consumption plus saving) - consumption to grow faster than income.

But Stevens says consumer confidence is neither weak nor strong and warns that the present saving rate isn't high, it's just back to normal. As well, "it would seem unlikely that we could bank on a resumption of sustained growth in assets [prices]", thus causing rising wealth to lead people to save less.

The household sector's apparent conclusion that its level of debt should go no higher makes it unlikely low interest rates will touch off another housing boom, although this "does not preclude prudent levels of borrowing by new entrants to the housing market, or by investors" (as existing borrowers continue paying down their mortgages).

As for non-mining business investment, its healthy growth is "by no means a certainty" and "looks like it is a while off yet".

Doesn't sound to me like a prospect where the highest priority of whoever wins the election should be getting the budget back to surplus.

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Bowen's statement: fantasy for grownups

The economic statement is a prime example of the dubious decisions politicians make when they put political survival ahead of sensible economic management.

On the face of it, the statement looks economically responsible. Its primary purpose is to recognise that the outlook for the economy has deteriorated markedly in just the few months since the budget in May.

It downgrades expected tax collections by more than $33 billion over the four years to 2016-17, with the economy now expected to grow by just 2.5 per cent this financial year - well below average - and the unemployment rate now expected to worsen from its present 5.7 per cent to 6.25 per cent by next June.

As a consequence, the Treasury projection at budget time that the budget would be back to surplus by 2016-17 was out the window.

No shame in that since most of the deterioration is due to factors beyond the government's control: the bigger than expected fall in export prices, the weaker outlook for the world economy, including China, and other setbacks.

But what would the opposition say about yet another delay in getting the budget back to surplus? And you can bet it will try to give the impression the bigger deficits are the result of wasteful government spending, not the rest of us having to pay less tax than expected.

So, what to do? Can Labor explain to the electorate the truth of why the budget remains in deficit, that when the economy's growth is so weak you would expect the budget to be in deficit - and that this actually stops the economy being weaker?

Gosh no. No, much easier to put yourself back on the hook and make a promise you don't know you can keep, to get the budget back to surplus in 2016-17, come hell or high water. Much better even to announce a rag bag of good and bad spending cuts, tax increases and accounting tricks on the eve of an election.

But this makes the economic statement a contradiction in terms: the economy will be in worse shape than we thought but, don't worry, we're announcing measures that run a high risk of making things worse.

And why? Because we are afraid of what Tony Abbott and Joe Hockey will say. That's bad politics, not good economics.

This statement offends the spirit of the government's medium-term fiscal strategy: instead of ensuring the budget returns to surplus as the economy strengthens, it tries to get it back to surplus in spite of the economy's weakness.

Should the government be re-elected, it will have tied its hands on the budget, promising implicitly not to use the budget to protect the economy should it fall into a slump, as there is a fair risk it could.

Of one thing we can be sure: whatever the budget balance is in about four years' time - 2016-17 - it won't be the projected surplus of $4 billion.

That's so far into the future it's utterly unpredictable. It could be better than that but it's much more likely to be worse. And that would be a bad thing only if the economy somehow roars ahead between now and then.

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We got our cut from the resources boom

Do you realise you've been hearing about the glorious Resources Boom for the best part of a decade? To economists, it constitutes the greatest bit of good fortune to come Australia's way since the Gold Rush. To many of us, however, it hasn't sounded nearly so wonderful.

For one thing, there's that word boom. We know booms can't last. And aren't they supposed to end in bust? For those of us of a certain age, it's not the first commodity boom we've lived through - and the previous ones did end badly.

So a commodity boom is a big improvement in our income that, just as we're starting to get used to it, suddenly disappears, leaving us with a hangover. Great.

And then there's the word resources. It leaves many of us feeling uncomfortable. We were never all that impressed by making our living growing things in the ground and selling them to foreigners, but digging up part of our ground and shipping it overseas seems even more primitive.

Is that the best we can do after 200 years of development? We send our children to school and university for that? How long can we get away with that? Obviously there's a limit to it. Won't it leave us high and dry?

I suspect many of us have drawn perverse satisfaction from the recent pronouncements that the boom has ended. At least the hoopla's over and we're getting back to reality. Time for the reckoning - and the recriminations.

What have we got to show for all that fuss? I'm sure some people must have benefited, but I know I didn't. Surely we should have saved more of that windfall rather than frittering it away on high living? And what do we do for an encore? Haven't we destroyed our manufacturing sector in the process?

These fears are examined in a report by Dr Jim Minifie, of the Grattan Institute, published on Monday. It makes reassuring reading.

If you don't work in mining, or live in Queensland or Western Australia, it's easy to conclude you've seen none of the benefits from this supposedly fabulous boom. But that's because people are conscious only of the benefits that come directly. The trick is that, when we all live and spend in the same economy, the benefits get spread around.

For most of us, the benefits have been indirect, but very real for all that. For instance, many people don't count the high dollar - and its cheaper prices for overseas holidays and other imports - as part of their gain from the boom.

Minifie finds that while people in the mining states did better, those in the non-mining states didn't miss out. Between the 2003 and 2013 financial years, wages rose by 2.7 per cent a year faster than inflation in the mining states and by 1 per cent a year in the non-mining states.

When you switch to looking at income per household, the ratio improves. Household income per person rose by a bit less than 4 per cent a year in the mining states and by 2.4 per cent a year in the non-mining states. Household incomes in the non-mining states grew significantly faster during the boom years than in the previous seven.

Unemployment didn't differ greatly between the mining and non-mining states. They began the period at much the same rate and ended it much the same.

Minifie finds that some regional centres did better than others through the boom, but among centres hit by the high dollar, most still experienced rising employment, thanks to steady economy-wide growth.

Only 14 towns, with a combined population of just 600,000, experienced falls in employment as a share of population, with no town losing more than two percentage points.

We keep hearing that the high dollar has "hollowed out" our manufacturing sector, leaving it incapable of recovering once the dollar comes down. (Tourism and some other industries have been equally hard hit, but no one worries about them.)

Despite a decline in employment in manufacturing, Minifie finds its output didn't fall, mainly because of increased demand from the resources sector. And although its exports fell overall, exports of more sophisticated manufactures grew.

"The experience of other countries that have been through a big shift in exchange rates suggests that Australian manufacturing is unlikely to have suffered permanent damage," he says. "If exchange rates decline, manufacturing is likely to bounce back to [its longer-term rate of growth] within a few years."

Much has been made of Minifie's finding that successive federal governments - Liberal and Labor - saved very little of the higher tax collections they enjoyed as a result of the boom. They gave away most of it in income-tax cuts (thereby improving your standard of living).

But despite the media's efforts to convince you otherwise, the federal budget is not the totality of the economy. Nor did all of the benefits from the boom go solely to the federal government.

The broader picture is that, as a nation, we have saved a high proportion of the proceeds from the boom. Greatly increased saving by households, and increased retention of earnings by companies, have more than outweighed the reduction in saving by governments.

The nation's overall saving rate is now about 3 per cent of national income higher than it was, equivalent to about $50 billion a year. Why are we so easily convinced we're losers?

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Costs of reform rarely mentioned by reformers

The idealised case for the social usefulness of the economics profession is that, within their area of expertise, economists offer the community dispassionate advice on the choices open to it, identifying the costs and benefits associated with each option and never failing to remind us that, whatever choice we make, it comes at an opportunity cost.

Unfortunately, those economists who belong to the economic rationalist faction often fall well short of this ideal. They don't offer dispassionate choices so much as passionately advocate one option over others, often exaggerating the likely benefits and brushing aside the direct costs and the opportunity cost of their preferred choice - which they sanctify by labelling a "reform".

Economic rationalists are the missionaries of materialism. They often step outside their expertise, failing to warn pollies or the public that their figuring has taken no account of non-efficiency considerations such as how the increased national income they promise will be distributed between rich and poor, and how the reform will affect family relationships, leisure, stress, trust and other forms of social capital.

This is why I was struck last week to see a lawyer, Geoff Giudice, former president of the (now) Fair Work Commission, doing what I don't remember ever seeing an economist do: reminding the community that "reform" comes with costs.

Giudice argued that, after four major reform acts on industrial relations law in the past 20 years, calls for further change should be approached with some caution.

"Reform has a cost. There are significant transaction costs [I'd say switching costs] associated with changes (and attempted changes) in labour legislation," he said. "There is the cost of consultation at many levels: for example, internal deliberations in various representative bodies, governments, community organisations and special advocacy groups.

"Lobbying, including representations to government and opposition parties, is not cheap. There are usually public relations and advertising costs of various kinds. Then the cost of the parliamentary process itself, including legislative drafting, the production of the associated parliamentary materials and sitting time, needs to be considered."

Should laws be changed after all that, there were usually significant implementation costs. In recent memory, very large amounts of money had been spent on changing staffing and other public service arrangements in response to legislative change, he said.

"There are other implementation costs related to compliance," he said. "Public information campaigns and industry education are needed. Employers can incur staff training, legal and other consultant costs ... Significant amounts of management time can be directed to dealing with proposals for legislative change."

The economic rationalists would no doubt reply that the continuing efficiency gain from their proposed reforms would soon dwarf these essentially once-off costs. But this doesn't justify their failure to acknowledge the costs of the reforms they advocate, the way they behave like high-pressure salesmen.

It doesn't justify the cases where reforms fail to deliver the promised benefits because of "unintended consequences" (which their oversimplified model didn't foresee).

How often do reforms fail to bring significant net benefits? Probably a lot more often than we realise. Reformers are guided much more by their preconceptions than by empirical evidence. They tend not to dwell on their failures, shifting the blame to the pollies' flawed execution.

Since we live in a democracy, however, it's inevitable that governments' execution will fall short of textbook purity. This being so, the gap between theory and practice is a sort of cost the reformers should take into their reckoning before assuring us we've nothing to lose.

And the rationalists' mentality that the need for reform is never-ending, that for governments not to be reforming something means they're not doing their job, that too much reform is never enough, creates an environment in which we get too much change.

The reform mania gives rise to plenty of failed attempts to get reforms through, too much pseudo-reform and too much oscillating change as we try centralising everything, then, when that doesn't work, try decentralising.

Particularly in industrial relations, we have too much battling between labour and capital to get the law slanted in their favour, all under the cover of "reform". Little wonder Giudice thinks the goal of any further change ought to be making the law more acceptable to both sides, thereby producing long-term stability and certainty in the legislative regime.

He says "when legislative change is proposed, all of the steps along the way from policy formulation, drafting, public debate and so on, through to implementation in some cases and abandonment in others, can be a wasteful distraction which displaces more productive activities".

It's taken a lawyer to remind the rationalists that reform itself has an opportunity cost.

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We've had enough IR reform to last us a while

At the Workplace Research Centre's annual labour law conference in Sydney this week, the topic was "Beyond Groundhog Day". Huh?

Parts of the media have worked assiduously to convince us industrial relations law is in terrible shape and in need of sweeping reform. So Tony Abbott has promised a major review, to be conducted by the hyper-rationalist Productivity Commission, with any proposals for legislative change to be taken to the election after this one.

But we've already had four "wholesale rewrites of Commonwealth industrial law" in the past 20 years. Do we really need another? Are we doomed to keep waking up to another day of system change until, after innumerable goes, we finally get it right? Should we keep striving for perfection, or is there something to be gained from a period of stability and certainty?

In case you haven't been keeping count, the first big change was in 1993, when the Keating government abandoned the highly unusual centralised system of conciliation and arbitration we installed at Federation and replaced it with a decentralised system of collective bargaining at the enterprise level.

Then we had Peter Reith's Workplace Relations Act in 1996, which downgraded the role of industrial awards and the Industrial Relations Commission, greatly reduced union power and inaugurated legislative recognition of individual contracts, known as "Australian workplace agreements", subject to a "no-disadvantage test".

In 2005 John Howard introduced his Work Choices legislation, which replaced the federal and state systems with a single national system, further reduced the role of the unions and the commission, further restricted the right to strike and further downgraded awards, essentially replacing them with a short list of legislated minimum conditions and annual minimum wage adjustments.

Initially, at least, he sought to encourage employers' use of individual contracts by removing the no-disadvantage test, meaning workers moved onto an Australian workplace agreement could indeed suffer a loss of pay or benefits.

And then in 2009 Julia Gillard passed her Fair Work law. It suits both sides in the eternal union-Labor, employer-Liberals IR battle to have you believe Fair Work completely reversed Work Choices.

In truth, it reversed some of it, but retained large parts. It ended statutory recognition of individual contracts, making collectively bargained enterprise agreements the main form of wage-fixing.

It restored the authority of the commission - now called the Fair Work Commission - and a greatly simplified "modern" award system, applying only to workers on less than $100,000 a year. It increased to 10 the number of legislated minimum "national employment standards" and restored streamlined unfair dismissal rules.

But it retained and strengthened Work Choices' national system and many of its measures to limit union power, including limits on unions' right of entry to workplaces, mandatory secret ballots before strikes, and bans on industry-wide strikes and pattern bargaining. It kept the ban on "secondary boycotts" (actions aimed at businesses other than the employer) in trade practices legislation.

It continued to limit the commission's power to settle disputes by compulsory arbitration, and to permit employers to lock out their staff without notice.

So where are we now? According to a speaker at the conference, Richard Bunting, a lawyer who usually represents employers, the present system has nine principal features. First, the state industrial relations systems have been emasculated.

Minimum wages and conditions are specified by statute, supplemented by modern awards. But these are very much minimums, with industry- or calling-wide awards no longer "owned" by particular unions and employer groups.

The system recognises only collectively bargained enterprise agreements, with workers not necessarily represented by unions and with "enterprise" defined only loosely. Workers have a statutory right to strike, but only during the bargaining period for a new agreement.

Individual workers enjoy freedom of association (to join or not join a union) and protection against certain "adverse action" by employers. Unions are less central to the operation of the system, but are still facilitated and protected. Finally, unions retain some rights of entry to workplaces.

The question is, are the industrial parties so unhappy with the operation of this system that another big review is needed, with major changes to follow?

Bunting said most of his nine principal features were settled.

"They reflect the contemporary society and economic circumstances," he said. "No mainstream political or industrial participant advocates a wholly different approach, much less a return to former regimes. We are in the midst of a new period of stability affecting the main features of our labour law. However, there are some aspects in contention and some aspects where there is an apparent lack of balance... "

Another speaker, Tim Lyons, assistant secretary of the ACTU, agreed we already have a stable regime. "With the exception of the issue of statutory individual contracts (a feature basically without parallel in overseas jurisdictions), the essential components of the current architecture . . . are seriously contested only at the margins," he said.

According to the keynote speaker, former justice Geoff Giudice, long-time president of the commission, "while there are some deep-seated differences in the positions of the major interests, it is important that many of the fundamental elements of the system are widely accepted. Policy differences tend to be at the margins or to be based on special pleading.

"There are some proposals for radical reform it is true, but extreme positions seldom provide a sound basis for change," he said.

Even Stephen Smith, of the employers' Australian Industry Group, though he had a long list of complaints, really only wanted change at the margin.

But the last word goes to Geoff McGill, former wages policy bureaucrat and employer consultant. "It is the substance of the employment relationship not its legal form which determines whether people are engaged and productive," he said.

"Productive workplaces are not the outcome of legislation but of the quality of leadership and culture at the workplace.

"There is a significant productivity dividend available to those organisations that have the leadership capability to harness discretionary effort of employees, through increased employee engagement."

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'Reform' just a marketer's word for change

Do you like change? I don't, and I don't know many people who do. And yet when it comes to the economy, people are always demanding change and more change from our politicians, and the pollies almost invariably seek our votes by promising it - better change than whatever their opponents are offering. These are promises they inevitably keep.

Some degree of change is unavoidable, of course. The environment in which we live and work is often changed by factors outside our control - particularly developments in other countries and the introduction of new technology - and we often don't have much choice but to change in response.

But we demand - and are given - a lot more change than the minimum necessary to cope with a changing world. Governments give us more change than we need for fear they'll be judged lazy or ineffective if they don't.

How does this paradoxical situation come about? It's simple: the change people demand of politicians and the change pollies promise isn't called change, it's called "reform". Slap on that label and the change we'd otherwise abhor becomes sanctified as virtuous, much-needed and far-sighted.

The politics and policy game involves thinking of a problem, then proposing a "reform" we fondly imagine will fix it. But our apparent love for reform means surprisingly little effort is put into checking how successful the supposed reform has been in delivering its promised benefits.

When a reform doesn't work this doesn't shake our enthusiasm for change, it just whets our appetite for more. We rush off for another round of "think of a problem and propose a reform". So great is our mania for reform we don't notice the not infrequent occasions when, in our efforts to solve some intractable problem, our efforts at reform keep oscillating from one approach to its opposite.

And it occurs to no one to query the wisdom of this incessant activity and reorganisation. Until now.

On Monday I witnessed the most remarkable speech from an authority figure I've heard in a long time. He was the former Justice Geoff Giudice, long-time president of the Industrial Relations Commission and inaugural president of the Fair Work Commission, speaking at the annual labour law conference in Sydney.

As you're well aware, the nation's been arguing furiously about industrial relations law at least since John Howard proposed his Work Choices "reforms" after the 2004 election. Along with the need for action on climate change, Work Choices is held to be a big part of the reason for Howard's defeat in 2007.

The new Labor government proceeded to introduce its own Fair Work "reforms", which consisted of reversing the most extreme elements of Work Choices while retaining much of its change and Howard's earlier changes in 1996.

Add in the Keating government's move to enterprise bargaining in 1993 and we've had four major changes in the industrial relations rules in just 20 years. But employer groups, chief executives and retired Liberal politicians, whipped up by the national dailies, are demanding an Abbott government implement substantial reform, moving the law back in the direction of Work Choices.

Having learnt the bitter lesson of the Liberals' 2007 defeat, Tony Abbott is promising only limited change, while pledging a major review of the system by the Productivity Commission, with any proposals for "reform" arising out of the review to be taken to the election in 2016.

Giudice argues in his speech that achieving a "stable and predictable industrial relations framework for the benefit of business, both here and overseas, for employees and for other stakeholders" should be a national imperative.

The question most often asked by politicians and their advisers, he says, is: what needs to be changed? "A more important question, which is rarely posed, is: how can greater stability be achieved in our industrial relations system?

"Stability is important from an economic and social viewpoint, although not perhaps from a political one. After two decades of change, much of which has been beneficial, further change is unlikely to lead to a net benefit for our economy unless it is the result of a much improved policy formulation process."

While there are some deep-seated differences in the positions of the major industrial interests, he says, "it is important that many of the fundamental elements of the system are widely accepted. Policy differences tend to be at the margins, or based on special pleading.

"There are some proposals for radical reform, it is true, but extreme positions seldom provide a sound basis for change."

I think Giudice is on to something. I agree we'd be better off with better industrial relations - that is, better relations between bosses and workers. But the path to better relations does not lie via yet another round of legislative change.

It doesn't lie in one side or the other using their political influence to get the rules shifted in their favour. We could go on playing that tit-for-tat game forever. But we have achieved a reasonable - if, inevitably, imperfect - balance, and it's time we gave up the delusion that legislative change is key to better relations in the workplace.

That's a job not for politicians, lobbyists, ideologues or media urgers, but for individual employers, their workers and their workers' unions. The parties on the ground need to focus on achieving greater co-operation in pursuing the business's goals, with fair sharing of the resulting rewards.

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The polls may have changed, but Labor hasn't

Am I the only person to be amazed by the way - if the polls are to be believed - the swapping of a leader has transformed the Labor government's election prospects from dead in the water to level-pegging?

Is that all it takes? Can the mere replacement of an unpopular woman with a popular man make a world of difference? Does it transform Labor's six-year record in government from disastrous to fair enough?

(Admittedly, Kevin Rudd's reinstatement has been accompanied by a change of faces among senior ministers, but I doubt Labor's miraculous recovery in the polls owes much to that nice Mr Bowen replacing that terrible Mr Swan.)

It's possible Rudd's improvement in the polls won't last but, regardless, we're witnessing a fascinating case study in the power of personality and perception versus policy reality and objectively measured economic performance.

Talk about the triumph of presidential politics. Could the superior TV persona of Rudd count for so much? Does the resurrection of Rudd mean Labor's no longer perceived to have stuffed up the economy? Does the removal of That Woman suddenly throw the spotlight on Tony Abbott's less-than-sparkling TV persona?

(The punters' perceptions of the relative attractiveness of Rudd and Julia Gillard are opposite to those of most of the people who've had personal dealings with the two. And Abbott in the flesh can be charming.)

Until evidence emerges to the contrary, I'm prepared to accept the possibility Rudd is a reformed character. After all, for him to have failed to realise the need for changed behaviour during his years in the political wilderness he would need to be pretty dumb.

And there's precedent for party leaders changing their spots: Bob Menzies (weak in his first stint, masterful in his second) and John Howard (ditto).

What I can't accept is that the restoration of Rudd constitutes any significant change in substance as opposed to packaging; in Labor's policies or its long-established operational strengths and weaknesses.

Has it suddenly acquired the courage of its convictions? Have its ministers gone from being career political apparatchiks to true believers? Has it switched from relying on its spin doctors' chicanery to relying on diligent salesmanship, from its obsession with criticising its opponents to untiring explanation of its policies' merits?

The most obvious demonstration of Rudd's lack of significant policy change is his decision to "abolish" the carbon tax, but replace it with an emissions trading scheme. Really? Abbott is right: whatever you call it, it amounts to a tax (just as his planned "levy" to finance his nanny-subsidising paid parental leave scheme is nothing other than a tax).

Bringing forward the move from a fixed to a floating carbon price by just a year hardly constitutes a radical policy reversal. And even the supposed fall from $24.50 to $6 a tonne in the carbon price may prove smaller than expected if the Europeans act to get their price back to where it's high enough to change behaviour, or even if our dollar falls against the euro.

Rudd's regional resettlement arrangement is unlikely to calm the frenzy over boat people. And it would be surprising if his imminent announcement of a tripartite agreement to put flesh on his seven-point plan to raise productivity proves path-breaking.

Actually, the haste with which he's wheeling out his policy adjustments is reminiscent of Gillard's behaviour after she toppled him: do some quick patch-ups (on carbon, boat people and the mining tax) before rushing to the polls to take advantage of her (as it proved, non-existent) honeymoon with the voters.

And there's another, more worrying parallel with Gillard. She was foolhardy enough to take a Treasury projection of budget surplus many years into the future and elevate it to the status of a solemn promise. When the projection proved astray (as they usually do) she endured several years of searching for real or cosmetic budget savings before being forced to an ignominious admission of failure.

The new Treasurer could have seized the opportunity to step back from the debt-and-deficit trap his predecessor had fallen into, but what did he do? Seized Treasury's latest projection of a return to surplus in more than three years' time (!) and made it a promise. This when the economy has already slowed to less than this year's growth forecast.

If the policy patch-ups keep coming with such haste this week and next, know the announcement of an election date isn't far off. And when you hear the Treasurer is producing an "updated economic and fiscal outlook", know the election announcement is imminent.

The pre-election fiscal and economic outlook documents produced by the econocrats a week or so into the campaign are always immediately preceded by the government's own statement, just so any revisions to the outlook are announced by the pollies, not their bureaucratic servants.

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Return to surplus less urgent as economy slows

It's a sad state of affairs when good sense about the budget emanates from commentators on the sidelines rather than the Treasurer and shadow treasurer. Yet such is the case, because of the opposition's consistently opportunistic approach to fiscal policy and the Labor government's chronic failure to stand up to the nonsense its opponents have been peddling.

So let me be the adult and tell you what Chris Bowen and Joe Hockey should be telling you, but aren't: the more anxious we become about the economy losing speed before we make the transition to non-mining-led growth, the less urgent it becomes to get the budget back to surplus.

You'd never know it when you think of how furiously the two sides have been squabbling over "debt and deficits" for the past four years, but Labor and the Liberals have a bipartisan fiscal policy. Both sides have essentially the same "medium-term fiscal strategy": to achieve budget balance on average over the medium term.

Everything I say here is consistent with that strategy - meaning much of what Bowen and Hockey say on the topic is inconsistent with it.

That clever strategy needs a lot of unpacking for non-economists. Because budget balance (or, in Labor's formulation, surplus) needs to be achieved only on average over a period of, say, a decade, it's saying there's nothing inevitably bad about deficits or inevitably good about surpluses.

So there'll be times when deficits are appropriate and times when surpluses are. Which is which? Deficits are appropriate when the economy is growing well below its medium-term "trend" rate of about 3 per cent a year; surpluses are appropriate when the economy is growing near, at or above trend.

Stick to that approach and, in the end, the deficits and surpluses will cancel each other out, leaving no lasting debt burden to be borne by our "children and grandchildren".

The next bit to be unpacked - which non-economists seem incapable of keeping in their heads for longer than five minutes - is that the process of the budget dropping into deficit when the economy is weak, then climbing back to surplus when the economy strengthens, happens automatically without the government raising a finger.

This is because of the operation of the budget's built-in "automatic stabilisers" which, when the economy is weak, cause tax collections to fall and welfare spending to grow and, when the economy is strong, go into reverse and cause tax collections to boom and welfare spending to fall.

So provided the government of the day doesn't make changes of its own volition that work in the opposite direction to the stabilisers, they can be relied on to leave the budget balance just where it ought to be as the economy moves through the business cycle.

The strategy doesn't prevent the government from adding its own "fiscal stimulus" at times when the economy is particularly weak, just as long as that stimulus is temporary.

As for other spending or taxing measures taken by the government, they need to be fully funded (by offsetting spending cuts or tax increases) if the operation of the automatic stabilisers is to ensure we end up with no lasting debt as a result of annual deficits exceeding annual surpluses.

All of this stands in stark contrast to the opposition's populist, economically illiterate line that deficits and debt are always a bad thing, always proof of economic mismanagement and (see above) always the result of things the government chose to do rather than things the state of the economy did to the budget (via the automatic stabilisers).

In his major speech this week, Bowen noted that the great challenge facing the economy over the next year or two is "rebalancing" - making the transition from growth led by the mining investment boom to growth led by the rest of the economy.

The question, he said, is whether the transition will be "smooth or bumpy". Bang on. That's exactly the question worrying the econocrats behind the scenes. Maybe it will be smooth, but maybe it won't. We know that, already, the economy is growing well below trend, causing unemployment to drift up.

Should it slow down much further, the rise in unemployment would quicken and become more worrying. And should mining investment fall off rapidly, before the acceleration in home building and non-mining business investment got going, it's conceivable the economy could slow to the point of contraction.

Trouble is, Bowen in his speech misdiagnosed the problem. He said the answer was Kevin Rudd's seven-point plan to get productivity improvement back up to 2 per cent a year.

Wrong. This confuses micro-economic policy (aimed at raising the medium-term trend rate of growth) with macro-economic policy (aimed at keeping the actual rate of growth as close as possible to the existing trend rate, thereby smoothing the business cycle). The point is that our main instrument of macro management, monetary policy (the manipulation of interest rates by the Reserve Bank), may not be enough to ensure we avoid a serious downturn. It may prove necessary to use fiscal policy as an emergency back-up.

If the economy suddenly slowed in a way that threatened to seriously shake business and consumer confidence and start a self-perpetuating downward spiral in private sector spending, the answer would be to step in quickly with a confidence-boosting "cash splash". We know from the global financial crisis how remarkably effective such measures can be.

Should that opportunity be missed, the next response would be to be ready with well-advanced plans for a program of heavy infrastructure spending to fill the vacuum left by the retreating mining investment boom. Even now the budget's growth forecasts are looking unachievable. If Bowen had any sense, he'd be toning down the rhetoric about getting the budget back to surplus in 2016-17 and making the point I began with.

If Hockey has any sense, he'll back off from the nonsense about debt and deficits, just in case he has the good fortune to inherit Bowen's problem.

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SURVEYING THE SCENE - PANEL DISCUSSION

Institute of Public Administration Australia NSW State Conference, Sydney

The most useful contribution I can make is to talk about the general economic and budgetary environment I think you’re likely to be facing in the next few years. I don’t want to depress you, but my best guess is that it’s likely to be increasingly challenging.

For a start, the Australian economy isn’t likely to be getting a lot of help from the rest of the world. The US economy looks like it’s finally on the mend, but it’s not likely to be setting any records for growth. The Europeans are still mired in their own problems - which could easily get a lot worse - and are likely to stay a drag on the world economy for many years to come. The Japanese economy has its own problems. As for China, it’s possible it will fall in a heap as the pessimists fear, but if it did it would bounce back pretty quickly and I think it’s more likely we’ll China continuing to grow, tho at rates of 6 or 7 per cent rather than 10 or 12. All told, we won’t be getting a lot of help from abroad.

As I’m sure you’ve heard, the big issue for our economy is for a ‘rebalancing’ - we need to make a transition from mining investment-led growth to growth in the rest of the economy, particularly home building and non-mining business investment. It may be we make this engine-swap without too much of a hiatus, but it’s not clear we will, and were mining investment to fall sharply before these other sources of growth got going properly it’s not inconceivable the economy could contract. The more we see the dollar fall the more confident we can be, and it’s likely we’ll see more cuts in interest rates.

All this says it’s hard to see federal or state tax revenue growing strongly in the coming years, which will inevitably keep a lot of pressure on the spending side of federal and state budgets. The Reserve Bank is very keen to avoid a real estate boom that would cause states’ collections from conveyancing duty to grow strongly, and consumer spending is likely to grow no faster than household incomes, which isn’t likely to be rapid. Added to this we have the structural weakness in collections from the GST, which is likely to keep a lot of pressure on the premiers before, eventually, the pressure gets so great that the premiers and the prime minister do a deal and increase the rate of the tax, or widen its base, or a bit of both.

Your problem isn’t just that the ordinary natural upward pressures on the spending side of state budgets are likely to be stronger than the upward pressure on the revenue side, it’s compounded by the medium-to-longer term structural spending pressures identified by successive federal intergenerational reports. It suits the politicians to portray this problem as the ageing of the population. If that were true, there wouldn’t be a lot for premiers to worry about. Unfortunately, the real problem is the irresistible pressure for very strongly growing health spending arising from expensive advances in medical technology - meaning it’s very much a problem for the premiers and well as the feds. When the states did their own intergenerational exercises a decade ago they found that hospital spending had the potential to take over their budgets in coming decades and I doubt anything’s changed. That says the health department will be under intensifying pressure to control cost growth, but its nonetheless rapid growth will keep pressure on every other state spending category.

One bit of good news is that, between the states, it’s now NSW’s turn to be among the faster growers, with Queensland and WA much harder hit by the downturn in mining investment. Another point worth remembering is that, tho the pressure to limit staff numbers and annual pay rises will remain, much of the strong growth in spending during the previous Labor government’s term went into correcting the long-running deficiency in public sector wage rates relative to private sector rates.

There HAVE to be better, more cost-effective ways to deliver the services the state government is responsible for delivering without great loss of quality - which is fortunate because the pressure on you guys to find those ways will only intensify in the next few years. If you’re planning to stick around my advice is to accept that reality and get on with finding those ways rather than thinking that if you drag your feet for long enough the brighter fiscal days will return. That makes it fortunate this conference is addressing itself to this challenge.

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Egalitarian facade hides growing inequality

One thing that makes me proud to be Australian is our tradition of egalitarianism. I love living in a country where Jack is as good as his master, where first names are so commonly used and men are more likely to address each other as "mate" than "sir".

When catching a cab overseas, I have to remind myself not to sit in the front with the driver and I love the way our government ministers - male and female - invariably sit up front in their chauffeur-driven cars, with staff members in the back seat.

It makes me proud to hear that in prisoner of war camps, the American soldiers tended to turn them into little economies and the Brits stuck rigidly to class privileges, whereas the Aussie officers and men shared all their meagre resources on the basis of need - meaning more of them survived.

And I was chastened years ago on an industrial relations junket as a guest of the German government. The Aussies in the group went out to see the sights one night in Munich. When, eventually, we decided to go back to the hotel we realised one of the group was missing.

I said I thought he was old enough and ugly enough to look after himself but an old union secretary demurred. "You blokes go back to the pub," he said quietly. "I'll have a look round for him. You never leave your mates behind."

You might think this egalitarianism would be reflected in a reasonably equal distribution of income between Australian households but that's far from the case. As the economics professor turned Labor politician Andrew Leigh reminds us in his most readable new book, Battlers and Billionaires, the latest figures show us having the ninth highest level of inequality among 34 rich countries.

It's probably not terribly well understood that, between Federation and the late 1970s, the gap between the highest and lowest incomes narrowed steadily, whereas since then, it has widened significantly.

The standard way to study the distribution of income is to compare the fortunes of the poorest fifth of households with those of the middle fifth and the top fifth. But Leigh has led the way in using income tax statistics to focus on changes in the share of total income commanded by the top 1 per cent of income earners.

He finds that, in the 1910s, the top 1 per cent (individuals who, by today's standards, enjoy pre-tax income of more than $200,000 a year) received about 12 per cent of all personal income. That is, 12 times what they'd get if incomes were distributed equally.

But this share declined steadily to reach a low of about 5 per cent of total income by 1980.

What caused this marked decline in inequality? Leigh shares the credit between the effect of the union movement (and, I'd add, our system of arbitration and conciliation) in protecting and improving wage levels, our governments' increasing reliance on income tax (with its progressively higher tax rates on higher income earners) and the development of our heavily means-tested system of welfare benefits, such as the age pension, child endowment and unemployment benefits.

He says the welfare system has twice the equalising force of the tax system.

The result was that, "under the prime ministership of Malcolm Fraser, the share of income held by the richest 1000th of Australians was only a quarter of what it had been under Billy Hughes [in the late 1910s]".

Since sometime in the late 1970s, however, this equalising trend - bringing the way the nation's income is shared more into line with our egalitarian ideals - has been reversed. The share of the top 1 per cent of income earners has recovered from 5 per cent to about 9 per cent.

Why? Leigh estimates the rise in inequality over the past generation can be attributed roughly equally to three factors, the first of which is technology and globalisation.

New technology's ability to give the best entertainers, sportspeople and even lawyers and other professionals access to a global market has hugely increased the incomes of a relative handful of individuals. Efforts to attract foreign chief executives to lead Australian companies have helped to force up the incomes of all chief executives.

Second is the decline of the union movement (including the move from collective bargaining to individual contracts), which has allowed many workers' wages to grow less strongly than other incomes.

Third is taxation, with moves to make income tax rates less progressive and rely more on indirect taxes.

My way of putting it is that, since the early 1980s, we have become more overtly materialistic in our values and political leaders have reacted by undertaking micro-economic "reforms", emphasising the primacy of economic growth and generally becoming more receptive to the demands of business.

The result is a lot more income, but also a lot less equal distribution of that income. The people urging this greater emphasis on materialism have captured most of the benefits while the rest of the community doesn't quite seem to have noticed what's going on.

I confess, I've been a winner from this process. What I'm not sure of is whether it leaves us better off as a community. Perhaps one day, the egalitarian facade will collapse and we won't like what we see.

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