Monday, August 12, 2013

How controversial change can still be achieved

As you see from Tony Abbott's unceasing attack on new taxes and both sides' wariness on calls for an increase in the goods and services tax, the politicians on both sides are certain voters are united in not wanting to pay a cent more in taxes.

This certainty is unshaken by much opinion polling seeming to suggest the contrary.

Which makes it remarkable that, with a minimum of fuss a few days before this year's budget, both sides agreed to raise all rates of income tax by half a percentage point from next July, and that this decision prompted hardly a peep from the public.

It's even more remarkable that this remarkable event has passed almost completely unremarked. The nation's usually unshut-upable media commentariat forgot to comment. Why? Because this highly unusual event happened so quickly and without controversy.

If you're not sure what I'm talking about, it's the decision to partially fund the national disability insurance scheme by increasing the Medicare levy from 1.5 per cent to 2 per cent. But why did this potentially unpopular event cause no controversy?

First, because the tax rise was directly linked to a popular new government spending program. The economic rationalists' long-standing disapproval of "hypothecation" is too rational by half. It fails to understand that accepting the need for higher taxes is an emotional judgment, that government and its budgets have become so huge and complex people can't see the connections any more and have become alienated from the process.

People are reluctant to give governments an open cheque: "How do I know what you'll use it for?" It amazes me economists can't see that people are attracted by the logic of a normal consumer transaction: if you want some item you have to pay for it; if you pay out money you expect to get something back in return.

But the second reason the decision to raise income-tax rates aroused little public opposition is because it became bipartisan. When oppositions oppose government reform proposals, the media seize on the controversy and give it much publicity.

All those who fear they may be adversely affected have a flag to rally around. And it's not just that. Many people take their attitude to a policy proposal from the stance adopted by the party they habitually support.

But when the potential opponents of a measure have no champion to rally around or see little sign of public sympathy for their objections, they tend to shut up and go along with the herd.

It surprises me that the advocates of controversial economic reform keep banging on about the need for our politicians to "show leadership" - that is, risk being tossed out of their jobs - when the clear lesson of history is that the Hawke-Keating government showed so much leadership in initiating micro-economic reform as it knew John Howard and John Hewson wouldn't seek partisan advantage by opposing reforms they, too, believed in.

Look at the way Labor toyed with a broad-based consumption tax while in government, but bitterly opposed it when the Howard government proposed it. And then, once in government, never for a moment considered modifying the supposedly evil tax.

Look at the way the Coalition took a carbon emissions trading scheme to the 2007 election to match Labor but then, when relegated to opposition, vociferously condemned essentially the same scheme. Previously silent climate-change deniers were let out of the closet.

And now look at the way Abbott opposes Labor's overt subsidies to the moribund motor vehicle industry but then opposes its reform of the fringe benefits tax on company cars because it would remove a hidden subsidy to the industry.

Or look at the way he criticises so many of the more recent tax increases and other measures Labor has used to try to plug the budget deficit, while carefully avoiding promising to reverse them in government.

The conclusion is clear: these days there's little ideology or principle in the opposing positions the parties adopt, just opportunism. You would implement much the same policy if you were in government but, since you're in opposition, you seek to gather the support of whoever is disaffected with the policy.

Our rival management teams are always seeking advancement by concocting difference where little exists. So the key to getting controversial reforms implemented is not to urge governments to be brave but to persuade their opponents to exempt this particular measure from their efforts to differentiate themselves, foster discontent and collect the support of disaffected minorities.

Obviously, two-party democracies work on oppositions opposing. But that doesn't require them to oppose absolutely everything.

This approach isn't likely to work, however, if the term "reform" is merely being used to disguise business rent-seeking. You do need genuine national interest.

Saturday, August 10, 2013

Using micro-economics to analyse savings account levy

Treasurer Chris Bowen says he's imposing a new savings account levy on our super-profitable banks, but the banks say they'll just pass it straight on to their depositors. They say it, but can you believe it?

Details of the levy haven't been announced, but we can piece them together. It won't take effect until January 2016, and it's expected to raise almost $750 million in its first 18 months. It will apply to all deposits of up to $250,000 in banks, building societies and credit unions.

It will be imposed at the rate of 0.05 per cent (5? per $100) on the balance in your account at a particular date each year. The proceeds will go into a separate "financial stability fund" until, after 10 years, the fund has accumulated an amount equivalent to 0.5 per cent of the value of all accounts guaranteed under the government's existing "financial claims scheme".

Money in the fund will be invested by the Future Fund guardians or a similar body. It can be taken out only to compensate people who've lost their savings in the unlikely event of their bank going under.

So the levy is like an insurance premium, a user-pays measure that means the banks will be paying for the benefit they receive from having the government guarantee their deposits of up to $250,000. Larger deposits will not be formally government guaranteed.

Needless to say, the banks hate the idea of having to pay for a guarantee they previously didn't have to pay for. And they've tried to gain public support by saying they'd be forced to pass the cost on to their customers.

But that's what businesspeople always say when they're fighting a new impost. As a consequence, they've spent decades inculcating in the public's mind the belief that markets are based on "cost-plus pricing".

The prices a business charges are simply a reflection of the costs the business incurs plus a margin for profit. So when a wicked government imposes a new cost on a firm, it has no choice but to pass it on. But economics teaches that cost-plus pricing is not the way markets work. That's because cost-plus focuses solely on the business's cost of supply, ignoring the role of customers' demand and their "willingness [or unwillingness] to pay".

On the other hand, economists well understand that the initial or legal "incidence" of a tax (the person required by law to write the cheque that pays the tax in to the taxman) isn't likely to be the same as the tax's final or effective incidence (the person who ends up actually bearing the burden of the tax). This is because the firm that bears the legal incidence will use whatever economic power it has to shift the burden of the tax either back to its employees or forward to its customers.

But anyone who has studied any economics knows it is unlikely to be true that all the cost of the deposits tax will be passed on to depositors. Early in an economics course you learn to test such arguments by drawing a diagram with price on the vertical axis, quantity on the horizontal axis and a supply curve sloping up to the right, crossed at some point by a demand curve sloping down to the right. The point where the two curves cross is the market price.

Shift the supply curve up to reflect the extra cost imposed on the firm by the tax and you soon see the increase in the market price is less than the amount of the tax, meaning some part of the tax has been shifted onto customers, but the rest remains borne by the firm as a reduction in its profits.

Why do firms and industries try to fight the imposition of new taxes by claiming they'll simply pass the tax on to their customers? If that's true, why are they getting so upset? Because they fear that, in truth, they'll have to bear some of the burden themselves.

It turns out that how much of the tax they can get away with passing on to customers is determined by the steepness of the slope of the demand curve, which represents the degree of "elasticity" (price-sensitivity) of the demand for the product.

When demand for the product is highly elastic (so that a small price rise causes a big fall in the quantity demanded), firms will have to bear most of the burden of the tax. Only in rare cases where demand for the product is perfectly inelastic (so that the quantity demanded is unaffected by changes in its price) will firms be able to pass on all the tax.

Unfortunately, this neat analysis - like much micro-economic analysis - is highly simplified: based on the assumption of "perfect competition". Among the many unrealistic assumptions of perfect competition, the most pertinent in our case is there are so many small sellers in the market none is able to have any effect on the price.

By contrast, banking is an oligopoly (a small number of big sellers) where each firm does have some degree of pricing power - especially when they act in concert.

But here's the trick. The banks' behaviour since the global financial crisis makes it much more likely the banks will protect their profits by passing on the burden of the deposits tax to their borrowers than to their depositors.

That's because the GFC caused the sharemarket, the ratings agencies and the regulators to pressure the banks to raise less of the funds they need from overseas and more from local depositors. Their competition bid up the "price" of deposits and they passed this increase in their "cost of funds" on to their borrowers by making "unofficial" increases in mortgage interest rates and passing on less than the full cuts in the official interest rate.

Their need to attract deposits remains, so they're likely to pass this small increase in their funding costs on to borrowers, not depositors.

Wednesday, August 7, 2013

It's the season for breakable promises

Election campaigns are dangerous things. They're dangerous for individuals who get caught in the crossfire between political leaders, dangerous for good policy and dangerous for the credibility of politicians. They're also times when policy statements fly so thick and fast we often fail to notice matters that affect us.

I suspect election campaigns have become more vicious, life-or-death affairs as politics has become less about convictions and more about careers - a ladder to be climbed by young people who leave university to work for a union or a politician, with ambitions to win preselection for a safe seat, make it into government, make into cabinet and then have a crack at the top job.

When almost all the opportunities for promotion or demotion come just once every three years, it's not hard to see why politicians get so desperate and campaigns so willing.

Business economists long ago learnt to keep their heads down and their lips buttoned during campaigns, for fear something they say is taken up by one side, prompting the other side to blacken their name. Too many people's careers have become collateral damage in the political fighting.

Election campaigns are when promises are made - some of them considered, some of them short-sighted, some of them on the spur of the moment to get out of a tight corner. When a government isn't at all sure it's going to win, its desperation often leads it to go for broke, making wild promises and worrying about how on earth it will keep them only if it manages to cling on.

When such incredible fuss was made over Ju-liar Gillard breaking her promise not to introduce a carbon tax, people were behaving as though such a thing was utterly unprecedented. The people who work in the House with the Flag on Top convinced themselves the era of easily made and broken promises was over.

Somehow, I doubt it. Elections have become too panic-stricken for the politicians to stick to a vow of scrupulous honesty. Already, and for the next five weeks, promises are being made that - whether or not the makers of those promises realise it - are destined to be broken. The hard part for voters is picking which ones they are.

Leaving aside those that never become operative because the party doesn't win, election promises can be divided into three categories: those the pollies make while having little or no intention of keeping them, those that are made and kept, and those made with good intention but broken because they're overtaken by events.

Too many voters have concluded most broken promises are in the first, knowingly dishonest category, whereas I suspect most are in the latter, overtaken category. Either way, our leaders would command more respect and trust from us if they made fewer promises and so were forced to break fewer.

I'm sure in their more reflective moments they realise they're trashing their own brand, but it doesn't seem to deter them - probably because the competition is so intense. "I would if he would, but I know he won't, so I won't. If I became scrupulous and he didn't, I'd get done."

A big part of the media's role in campaigns is trying to extract promises from pollies - "Will you guarantee no one would be worse off from your policy? Do you promise you won't ... ?"

I'm sure the journalists who ask such lazy questions think they're performing a public service, but I have my doubts.

When can politicians ever promise that no one will be worse off? Why would it be smart for our politicians never to make any change that involved losers? Is life that easy? Why is it always in our interests to have our leaders close off their options in coping with an unknown future?

That's the trouble, of course: none of us knows with any certainty what problems will arise over the coming three years. And yet election campaigns are conducted on the mutual and tacit assumption we do know - as with last week's economic statement, where the government pretended it knew exactly how the economy would perform between now and 2017, and how this would affect its budget down to the last dollar. And the rest of us nodded wisely.

It was to reinforce the illusion of being in control of the future that Labor announced four major tax measures in just the past week or so. One is a supposed 60 per cent increase in the excise on cigarettes, one an effective increase in the fringe benefits tax on company cars and the third is a new levy on bank deposits.

Another, deliberate feature of election campaigns is that the announcement of plans and promises is so fast and furious they flash past without properly registering on our consciousness. The increase in tobacco excise will be phased in over three years in a way that, combined with another recent change, will cause the excise to double in five years.

The company car measure won't take effect until April next year, while the bank deposit tax - the details of which haven't been revealed - won't start until 2016.

And the fourth measure? A solemn promise not to change the tax treatment of superannuation for five years. Nothing to hurt you in that one? That's what they want you to think.

Monday, August 5, 2013

Hockey's populism ties Labor in budget knots

The political experts don't seem to have noticed how successfully Joe Hockey has outfoxed Chris Bowen and Kevin Rudd on the questions of budget promises and perceptions of economic competence.

Hockey's fast footwork achieved its most dramatic success on Friday when Labor re-nailed itself to the cross of a Treasury budget projection almost four years into an unknowable future only a few months after Wayne Swan and Julia Gillard had so painfully torn themselves down from the selfsame cross.

And to give this triumph of hope over experience some shred of credibility, Bowen and Rudd thought it best to announce spending cuts and tax increases worth a net $10 billion over two years just a few days before the start of an election campaign.

Most of those political nasties don't really bite for at least two years but, never mind, take the political pain now.

Would Labor have done something so politically costly - and economically foolhardy - had Hockey and Tony Abbott not inveigled them into it with five years of populist nonsense about ''debt and deficit'', with their economically illiterate contention that budget deficits are always and everywhere a bad thing and always the product of wasteful spending decisions, never the weak state of the economy?

What the political experts haven't noticed is that Hockey has conned Labor into being so foolish while quietly manoeuvring himself into a position where he and the Liberals won't be matching Labor's folly.

When, a week ago, Hockey trumped up a story about how he'd take no notice of the econocrats' pre-election economic and fiscal outlook statement (the ''pee-fo'') - to be released no more than 10 days into the election campaign, and now sure to be virtually identical to Bowen's statement - because Treasury couldn't be trusted, the political types thought it meant he was refusing to let Treasury and Finance cost the Coalition's election promises.

But oppositions never let Treasury cost their promises because it's too politically risky. That's why taxpayers have been run to the expense of setting up the Parliamentary Budget Office. Hockey did say he'd be using the office to cost at least some of his promises.

For months Hockey's been saying he couldn't possibly release his costings until he'd seen the pre-election economic and fiscal outlook statement. This convenient excuse for delaying the release of detailed policies until the last possible moment before the election wasn't justified by his need to use the statement to cost particular promises.

No, it was justified by the need to see Treasury's most recent stab at the expected budget balances over the next year or two so the opposition would know how much it could afford to spend. It would also allow the Liberals to commit to achieving Treasury's forecasts or bettering them by $x billion.

Penny dropped yet? By claiming the fiscal outlook statement couldn't be trusted, Hockey was freeing the opposition from having to make anything but the vaguest commitment about when it would get the budget back to surplus, even though its opponents had nailed themselves to a hard and fast target.

In this Hockey isn't just being politically fast-footed, he's also being economically wise. When the outlook for the economy is so uncertain - with, as the Reserve Bank governor spelt out just last week, a lot of things needing to fall into place before we return even to trend growth - Hockey is keeping all options open, while Bowen is busily closing them.

If, God forfend, the economy were to slow to the point of contraction sometime in the next four years, Bowen would have to break a promise to do anything about it. If growth were still below trend in two years, he's pledged to make things worse.

The opposition's wider - though unscrupulous - political achievement is convincing the media the federal budget is the economy, that the ultimate test of good economic management is not to keep the standard of living rising or stop unemployment worsening, but to get the budget back to surplus come hell or high water.

Its success in this deception - which includes convincing the media Labor's utterly remarkable finesse in minimising the effects of the global financial crisis was just an exercise in monumentally wasteful government spending - is thanks to Labor's lack of courage, talent and commitment to enlightened macro-economics.

Bowen's best excuse is that, after five years of dereliction and intellectual dishonesty, it was far too late to try to turn things around.

But the greatest absurdity of the economic statement is the way grown men and women could pretend it was possible to say anything meaningful about the state of the economy or the budget balance in three or four years.


Saturday, August 3, 2013

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.

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.

Wednesday, July 31, 2013

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?

Monday, July 29, 2013

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.

Saturday, July 27, 2013

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."

Wednesday, July 24, 2013

'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.

Monday, July 22, 2013

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.

Saturday, July 20, 2013

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.

Wednesday, July 17, 2013

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.

Monday, July 15, 2013

Sorry, productivity isn't almost everything

To be frank, I don't lay awake at nights worrying about how Australia is going to lift its rate of productivity improvement back to 2 per cent a year. Contrary to the impression Kevin Rudd is trying to convey with his seven-point productivity plan, higher productivity would do little to help us make the transition to the post-resources boom world.

The biggest risk in the potential hiatus between the waning of the boom and the return to healthy growth in the non-mining economy is an unacceptable rise in unemployment, and higher productivity won't fix that.

For one thing, the threat to employment is immediate and relatively short term, requiring deft management of the macro-economic levers, not the longer-term measures needed to enhance our productivity performance.

More fundamentally, improved productivity is about increasing our material standard of living - real income per person - not about increasing employment (which, in any case, shouldn't be more than a temporary problem).

I worry a lot more about whether our existing high material standard of living is compatible with the preservation of a healthy natural environment - including one that avoids excessive global warming - than about how we can drive our consumption levels even higher. The origins of the very resources boom we're struggling to adjust to - and our hand-rubbing contemplation of Asia's rapidly growing middle class - ought to be making us wonder whether the globe's natural resources and ecosystem will be able to cope with so much affluence.

So if we fail to get productivity improving at the rate of 2 per cent a year rather than 1.6 per cent, I won't be shedding too many tears. Apart from ecological sustainability, I give improving our non-material quality of life a much higher priority than increasing the number of cars, TV sets and gadgets per home.

But for all the business people, economists and politicians who profess to care so deeply about accelerating our rate of consumption let me offer some advice: you won't get far until you can see past your sectional interests and ideological hang-ups. If the hyper-materialists were genuine in their drive for faster productivity improvement they'd be ascertaining those measures likely to do most to enhance productivity and resolving to pay whatever price was necessary to bring them about.

But that's not what they're doing. Rather than asking which measures would be most effective, they're asking which measures they'd be most comfortable with. Whether the most comfortable measures would be particularly effective doesn't seem to worry them. Take the business lobbies. They're proceeding on the theory that anything making life easier for business must surely be good for productivity. So top of their list is a return to individual bargaining in industrial relations, followed by measures that reduce the tax burden on business and increase it for everyone else. As for the economists, they're really only interested in measures that fit their model's built-in presumption against government intervention in the economy.

So their preference is for measures that reduce intervention - micro-economic reform - and do little to add to government spending and taxation. The first problem with this approach is that it's generally unpopular with the electorate and invokes fierce opposition from vested interests, mainly business interests.

Successive governments have been reluctant to undertake further micro reform for well over a decade. So if more micro reform is the key to faster productivity improvement don't expect to see much improvement.

The second problem with the economists' approach is it means they have little enthusiasm for productivity enhancing measures that involve significantly increasing government spending.

Trouble is, this includes the two areas where big productivity gains are most likely to be found: greater investment in education, training and research to increase human capital, and greater investment in public infrastructure to improve the conditions in which our businesses operate.

It shouldn't be assumed that all we need to improve education and infrastructure is a lot more spending. But nor should it be assumed - as many economists do - that all that's needed is reformed government intervention in these areas. In truth, both better intervention and a lot more spending are needed. The first part is tricky, the second is ideologically unfashionable (as well as requiring higher taxes).

To be sure, the Labor government is already spending a lot more on education and training, and this should favourably affect productivity in due course. Ideological blinkers have prevented many people from seeing that the Gonski reforms to direct greater funding to disadvantaged students should have a productivity pay-off - as should the national disability insurance scheme.

My guess is any improvement we see in our productivity performance will happen more in spite of all the speech-making on the topic than because of it.

Saturday, July 13, 2013

Yes, we are going through a weak patch

The economy is going through a weak patch. The resources boom is coming off, but the rest of the economy has yet to take up the slack. That's partly because the dollar has been so high until recently and partly because business and consumer confidence have been weaker than they should be.

I was lecturing an interviewer on our tricky transition when he stopped me in my tracks by asking what "metrics" I based this judgment on. Since he was used to interviewing business people, I suppose it was a fair enough question.

I could have said I based it on the high rate of company tax, the carbon tax or some other fashionable business complaint.

But being a boring economics writer, the "metrics" I was using were the obvious ones: what the Bureau of Statistics' quarterly national accounts are telling us about the rate at which the economy's growing and what its monthly survey of the labour force is telling us about employment and unemployment.

The two indicators act as largely independent checks on each other. The latest national accounts, for the March quarter, showed real gross domestic product growing by 2.5 per cent over the year to March, and by about the same annualised rate in the March quarter itself.

How do we know whether 2.5 per cent is good or bad? Well, it's well short of the economy's "trend" growth rate of about 3 per cent. The economy's trend rate of growth is its "potential" growth rate: the maximum rate at which our production of goods and services can grow over the medium term without causing inflation pressure.

Our potential growth rate is set by the average rate at which our productive capacity is expanding as a result of growth in "the three Ps" - the population of working age, that population's actual rate of participation in the workforce and the productivity of its labour (determined by business investment in equipment, public investment in infrastructure, the skill levels of the workforce through education and training, and technological advance).

The econocrats' estimate of our potential growth rate has recently been cut from 3.25 per cent to 3 per cent a year because the continuing retirement of the baby boomers is reducing the participation rate.

As the word "trend" implies, our potential growth rate is a medium-term average. When the economy's coming out of a recession it can grow faster than its trend rate until all its spare production capacity (including unemployed and underemployed workers) is taken up.

So when the economy is growing below its trend rate, this implies it isn't growing fast enough to create sufficient additional jobs to stop unemployment rising.

And that's just what the labour force figures confirm is happening. The figures we got this week for June, for instance, show the rate of unemployment creeping up from 5.6 per cent to 5.7 per cent.

In truth, it's been creeping up for some time. Using the bureau's much clearer smoothed seasonally adjusted figures (also confusingly known as the "trend" estimates), the unemployment rate was 5.2 per cent in June last year, but 5.7 per cent in June this year.

Last December it was 5.4 per cent, implying its rate of worsening is a little faster in recent months. This, in turn, suggests the economy's rate of growth in the June quarter may have been a little slower than a 2.5 per cent annualised rate.

Note that employment is still growing, though at a slower rate - only about 7500 jobs in June, compared with about 18,000 jobs a month around the turn of the year - with almost all the new jobs being part-time.

The trick is that size of the workforce keeps growing - as a result of natural increase and immigration - so if the economy isn't generating enough additional jobs, unemployment must rise.

Just how long the economy goes on slowing and by how much are questions we can only guess at. It will be determined, obviously, by how quickly the resources boom comes off, on the one hand, and how long it takes the non-mining economy to pick up speed on the other.

The huge growth in investment spending on new mines and natural gas facilities looks like it's at its peak, but we don't yet know whether it's reaching a plateau or will fall away quite quickly. Since mining investment has been the biggest factor driving economic growth in recent years this is a key question.

Similarly, it's hard to predict how long it will take the rest of the economy to recover its mojo and return to normal rates of growth. In particular, non-mining business investment has been a lot weaker than usual, as has households' investment in home building.

What reason is there to expect the non-mining economy to return to more normal rates of growth? One reason is the belated (and, as yet, still insufficient) fall in the dollar following the retreat in our mineral export prices.

This will act as a stimulus to our export and import-competing industries. Another source of stimulus is the easing in monetary policy. The Reserve Bank has been lowering the official interest rate since November 2011, cutting it from 4.75 per cent to 2.75 per cent. Monetary stimulus takes a fair while to have its full effect on the willingness of businesses and households to borrow and spend.

It's always possible the economy could slow to the point where it was contracting rather growing, but it's rare for growth to simply peter out in such a way - partly because it can be seen coming, leaving the economic managers time to take corrective action.

Just as the Reserve has been doing, of course. With this week's evidence of further weakness - and assuming it's confirmed by a low inflation report on July 24 - it won't be surprising to see the Reserve cut rates again.

After that, the next stimulus weapon would be fiscal policy - the budget. The new Treasurer, Chris Bowen, would be well advised to keep his options open.

Wednesday, July 10, 2013

The jobs will come, as they always have

I can't make myself sleep on the long plane trip to or from Europe. These days I just keep myself distracted by the plane's entertainment system. Returning at the weekend from a walking holiday in England, I really enjoyed rewatching the Jack Nicholson movie As Good As It Gets, with its theme tune, an American-sanitised version of Always Look on the Bright Side of Life.

In Australia we're usually a land of bright-siders, though this hardly makes us unique. It's actually this optimism about the future that keeps our economy moving onwards and upwards.

At present, however, we're looking on the dark side. Until recently it was fashionable to complain that, whoever was benefiting from the resources boom, it wasn't you or me. These days, the worry is that with the initial stages of the resources boom passing its peak, it's hard to know where the growth and the jobs will be coming from.

Did you detect the logical inconsistency between those two worries? They can't both be true. If most of us gained nothing from the boom, most of us have little reason to mourn its departure. All the two positions have in common is their pessimism.

Yet despite all the political and economic commentary to which we're exposed, it took a speech last week from Reserve Bank governor Glenn Stevens to point out the contradiction.

The truth is you and I got plenty of benefit from the resources boom. The reason so few of us realise it is that most of those benefits were indirect. We often have trouble joining the economic dots.

One of the most easily detected indirect benefits of the boom is the high dollar which, among other things, has made it so much cheaper for us to take overseas holidays (and, until recently, left the world crawling with Aussie tourists).

Now, with the resources boom receding and the American economy finally picking up, the dollar is coming down again, allowing those who never acknowledged the high dollar's benefit to complain about its departure.

But the trick is that everything that happens in the economy - whether popularly judged to be good or bad - has both advantages and disadvantages. So to every seemingly good thing that happens there's always a downside, while to every bad thing there's an upside.

The disadvantage of the high dollar was that it made it harder for Australian businesses to compete on export markets and against imports in the domestic market. So the advantage of a lower dollar is that it takes pressure off a lot of Australian businesses - not least of which are our tourism operators - making it easier for them to expand their sales and employment.

When I was younger I used to dread times like this, where the economy was looking flat and everyone was demanding to know where the jobs would be coming from. How should I know?

Usually that question is asked in the later stages of a severe recession, when people are depressed and doubtful whether the economy has a future. We haven't had a severe recession for more than 20 years - a record for us and better than any other rich country can say - and yet we're feeling down. (Sometimes I think we're feeling down precisely because so many of us have no recollection of what genuine economic hardship feels like.)

By now, however, I no longer dread being asked where the jobs will be coming from. I know from the experience of three severe recessions that there's always a tomorrow. I don't know the precise details, but I do know the jobs will come. Always have in the past and no reason to doubt they will again.

What's more, in this case past performance does offer a reasonable guide to the future. As Stevens reminded us in last week's speech, over the 21 years to mid-2012, our production of goods and services roughly doubled. Only 3 percentage points of that 100 per cent increase came from manufacturing.

The largest contributions came from financial services (13 percentage points), mining (10 points), construction (9 points), professional services (8 points) and healthcare (7 points).

But though production and employment are related, they're not the same, with some industries being a lot more labour-intensive than others. Over the same period the number of jobs in the economy has increased by about half. About two-thirds of this increase is attributable to growing employment in the provision of various kinds of services to businesses and households.

There's been growth across the board in services sector employment, but healthcare accounts for 9 per cent of the increase and professional services for 7 per cent.

One beauty of the services sector is that it provides unskilled jobs - for waiters, cleaners, shop assistants and the like - but also, and increasingly, highly skilled jobs for managers, medicos, teachers, lawyers and all manner of professionals and para-professionals.

So that's where the jobs will come from, and come they will. It's not the government's job to ''create'' those jobs any more than it was its job to conjure up the resources boom. That's the job of business and, indirectly, households.

It will happen when businesses and householders get their confidence back - which we can be sure they will. What we can't be sure of is that this will happen on cue.


Monday, June 10, 2013

In the business game, less is often more

It's a holiday, so let's talk about sport not business - for openers, anyway. Indoor handball is a team sport where players face a constant stream of quick decisions about what to do with the ball: pass, shoot, lob or fake?

Players have to make these decisions in an instant. Would they make better decisions if they had more time and could analyse the situation in depth?

In an experiment with 85 young, skilled handball players, each stood in front of a screen, dressed in his uniform with a ball in his hand. On the screen, video scenes of high-level games were shown. Each scene was 10 seconds long, ending in a freeze-frame.

The players were asked to imagine they were the player with the ball and, when the scene was frozen, to say as quickly as possible the best action that came to mind.

After these intuitive judgments, the players were given more time to inspect the frozen scene carefully, and name as many additional options as they could. For instance, some discovered a player to the left or right they had overlooked, or noticed other details they weren't aware of under time pressure.

Finally, after 45 seconds they were asked to conclude what the best action would be. In about 40 per cent of cases this considered judgment was different from their first choice.

OK, that's enough fun. Back to business. We live in a business world where the thinking of educated people has been heavily influenced by rational analysis. For instance, one rational conclusion is that to make good decisions we need the best information possible. To be better informed is to perform better.

These days, all switched-on managers know they need an adequate business information system - the right "metrics" - to be fully informed about their business's performance and so be able to make the right decisions to keep it scoring goals.

To the rationally trained person, more information is always better and more options to choose from are always better. Economists add the qualification that information is often costly, so you shouldn't keep collecting it beyond the point where the additional cost exceeds the additional benefit.

Practical managers know there's a trade-off between speed and accuracy. It's good for decisions to be as accurate as possible, but it's also good for decisions to be made without much delay. So the smart manager finds a happy medium between accuracy and speed, knowing they're sacrificing some accuracy for a speedy decision.

Back to handball. This experiment was recounted by German psychologist Gerd Gigerenzer, of the Max Planck Institute in Berlin, in his book Gut Feelings. To measure the quality of the actions the players proposed, the experimenters got professional-league coaches to evaluate all proposed actions for each video.

They found that, contrary to the notion of a speed-accuracy trade-off, taking time and analysing didn't generate better choices. The players' gut reactions were, on average, better than the actions they chose after reflection.

Indeed, the order in which possible actions came to the players' minds directly reflected their quality: the best came to mind first, the worst came last. This result is consistent with many experiments showing that, though the inexperienced need to think it through carefully before they take a golf shot, drive a car, or tie their shoe laces, the experienced do better if they don't think about what they're doing but simply do what comes naturally.

This is consistent with another finding that chicken sexers, chess masters, professional baseball players, award-winning writers and composers are typically unable to explain how they do what they do.

In some circumstances, more information and more time to process it is better. But a surprising amount of the time less turns out to be more.

Gigerenzer says this will be so in cases where we're relying on unconscious motor skills. It's also true when the limits of our brain power mean we make better decisions if we don't confuse ourselves with too much conflicting information.

Our brains seem to have built-in mechanisms, such as forgetting a lot of things and starting small, that protect us from some of the dangers of possessing too much information.

A famous experiment involving selling different flavours of jam in a supermarket found that having too many choices leads to decision-making paralysis. Offering a choice of six led to more sales than a choice of 20. It doesn't follow, however, that offering an even smaller choice would increase sales further.

Gigerenzer's other conclusion - of particular relevance to business decision-making - is that empirical testing can reveal simple rules of thumb that predict complex phenomena as well or better than complex rules do.

Saturday, June 8, 2013

Economy yet to make transition to post-boom world

The economists' buzzword of the week - and probably the year - is "transition". If it's not in your lexicon add it immediately. You'll need it - because this week we learnt how tricky it's likely to be.

As the construction phase of the resources boom nears its peak, the economy needs to make a transition from mining-led growth to growth led by all the normal sources: consumer spending, home building and non-mining business investment.

This week the national accounts for the March quarter from the Bureau of Statistics showed growth in real gross domestic product of just 0.6 per cent for the quarter and 2.5 per cent for the year to March.

For once this seems a reasonably reliable reflection of how the economy's travelling. It's not disastrous, but nor is it satisfactory.

The economy needs to be growing at its medium-term trend rate of about 3 per cent a year. Growth of that order is needed just to hold unemployment constant. And since we've been falling short of it for about a year it's not surprising that, over the year to April, the unemployment rate has drifted from 5.1 per cent to 5.5 per cent.

(If you had it in your mind our trend growth rate was nearer 3.25 per cent, you're not wrong, just out of date. The econocrats have lowered it to 3 per cent to take account of the ageing of the baby boomers, which means a larger proportion of the population is now in an age range with lower participation in the labour force.)

The worrying thing about this week's figures is that they reveal the pressing need for a transition from mining-led to broader growth, but not much sign it's about to happen.

As best he can determine it, Kieran Davies, of Barclays bank, estimates mining investment spending fell about 7 per cent in quarter. Rather than rising, however, non-mining investment spending fell about 3 per cent.

At the same time, new home building (including alterations) was flat. Consumer spending strengthened to grow 0.6 per cent, but this was still below trend.

Public sector spending grew 1.1 per cent, but this followed a much bigger fall the previous quarter and with all the pressure on state and federal governments to balance their budgets, we shouldn't expect much help from the public sector.

According to the opposition, the Gillard government's been doing far too much to help.

It turned out a lot of the growth in the March quarter came from "net external demand". The volume (quantity) of our exports grew 1.1 per cent, whereas the volume of imports fell 3.5 per cent, meaning "net exports" (exports minus imports) made a positive contribution to growth of 1 percentage point.

Some silly people have been saying if it hadn't been for net exports the economy would be in a bad way - which is a bit like saying if we cut off one of our arms we'd be in a bad way. What they're missing is that the growth in export volumes will be lasting (they grew 8.1 per cent over the year to March) because it's coming from strong growth in exports of coal and iron ore, as new mines come into production and the third phase of the resources boom kicks in.

In other words, it's wrong to imagine the boom's about to leave us high and dry. Mining production and exports have a lot further to grow in coming years. Even the fall in imports (which constitutes a reduction in their negative contribution to growth) is linked to the boom: reduced investment in new mines means reduced imports of capital equipment.

As for the second, construction phase of the boom, spending from quarter to quarter is too variable to allow us to conclude this quarter's fall means the peak has been passed. Maybe, maybe not. Nor is it clear how precipitous the fall will be when it arrives. It may be fairly gentle since the miners' pipeline of committed projects still stands at a record high of $268 billion.

What reason is there to hope the non-mining sources of growth will strengthen? The main one is that the Reserve Bank has cut the official interest rate 1.5 percentage points in a little over a year, taking the "stance" of monetary policy to its most stimulatory in many a moon.

Everything we know tells us lower interest rates encourage borrowing and spending, particularly in interest-sensitive areas such as housing and the purchase of consumer durables. We also know it often takes a while to work. In my experience, it's just when people are running around saying it isn't working that it starts to.

Of course, a significant fall in the dollar would help a lot by improving the international price competitiveness of our export and import-competing industries, particularly manufacturing and tourism. It would help them produce more for export and replace imports in the domestic market. (So much for those who think it makes sense to assume away net exports.)

The dollar does seem to have fallen about US7? in the past few weeks. This may be some help, but it's far short of what would be justified by the deterioration in our terms of trade (the passing of the first phase of the boom) and what our traders need to restore their competitiveness.

The best hope for further falls in the exchange rate is not further cuts in our official interest rate (its role is widely overrated) but better prospects for the US economy leading to expectations of the cessation of "quantitative easing" (metaphorically, printing money), which has the side effect of putting downward pressure on the greenback. The Reserve has been cutting rates since November 2011, not to induce a fall in our dollar so much as to offset the contractionary effect of its failure to fall as export prices have fallen.

Should the dollar keep falling the Reserve won't cut rates any further. Should the dollar fail to keep falling, it probably will.

Wednesday, June 5, 2013

We can be fairer and more efficient at the same time

Humans are a pattern-seeking animal but also a categorising animal. We're forever trying to get a handle on how the world works by sorting things into different boxes. When we can slap a label on something or someone, we think we've understood them.

It's fashionable among our business people to divide the world into "wealth creators" (them) and "wealth distributors" (everyone else but particularly governments). Wealth creators are the source of all prosperity; wealth distributors are essentially parasitic.

Economists' favourite boxes are similar, but not quite so crude. They divide policy objectives into "efficiency" (promoting economic growth) and "equity" (ensuring a reasonably fair distribution of the fruits of that growth).

For the most part, economists see efficiency and equity as in conflict. They care deeply about promoting efficiency but often leave it to others to worry about equity - unless they fear some equity measure would lead to inefficiency.

But sometimes our habitual ways of categorising things can be a hindrance to understanding and progress. Sometimes the labels on boxes don't adequately describe their contents, which can have more in common than we realise. Sometimes we "frame" problems in ways that conceal their solutions.

A new book, Inclusive Growth in Australia, proposes just such a new way of thinking about equity and efficiency. It's edited by Professor Paul Smyth, of Melbourne University and the Brotherhood of St Laurence, and Professor John Buchanan, of the workplace research centre at Sydney University.

A lot of economists and business people are worried about a fall in the rate at which the economy's productivity is improving. Productivity measures the efficiency with which we take inputs of land, labour and capital and turn them into outputs of goods and services. It normally improves by a per cent or two a year but it's been weak for about a decade.

It's our improving productivity - brought about by advances in technology, improvements in public infrastructure and a better educated and more skilled workforce - that causes our material standard of living to keep improving. It also helps to have a higher proportion of the population participating in the workforce.

To date, the deterioration in our productivity performance has been concealed by the resources boom, with its higher prices for our exports and hugely increased construction of new mines. But, the economists worry, now the boom is passing its peak, people will really feel the absence of ever-rising incomes.

So what's the Gillard government doing about it? Ignoring wealth creation and worrying about perfecting the way it's distributed. It's going to the election with two policy changes in pride of place: a disability insurance scheme and the Gonski changes to school funding.

All very worthy, no doubt, but talk about fiddling while Rome burns. But here's where the proponents of "inclusive growth" have a useful perspective. They say that far from being an irrelevance or an indulgence, social policy can, if you do it right, constitute an investment in improving the economy's performance.

As it happens, both the disability scheme and the Gonski reforms are good examples. Many physically and mentally disabled people - and their voluntary carers - would dearly love to make a greater contribution to the paid workforce, if they were enabled to.

And intervention to assist the disabled can be strategic: do it the right way at the right time and much subsequent expense - not to mention personal anguish - can be avoided. No more soft-headed authority than the Productivity Commission attests to the ability of the disability scheme to add to national income.

Similarly, it doesn't take too much thought to realise changing the basis for federal grants to public and private schools to one that gives more to schools with disadvantaged students can been seen either as a move to greater fairness - improving their equality of opportunity - or a move to greater efficiency.

We have no trouble seeing the benefit of doing more to assist the education and training of our brightest and best but much trouble realising the same applies at the bottom end. If, by giving them greater and more timely assistance, we could reduce the number of kids who drop out of school - or make it through with inadequate levels of literacy and numeracy - we'd be making them more productive workers.

The main lesson to be learnt from the league tables showing how our students' educational attainment compares with those in other countries is not that our best students aren't keeping up but that there's a widening gap between our best and our worst.

Another theme of the inclusive growth advocates is "flexicurity" - improving unemployment benefits and assistance to the jobless so as to reduce resistance to the unceasing change in the structure of our economy as the poor countries develop and the digital revolution proceeds.

I think the search for ways to kill two birds with one stone is a good one - just as long as it doesn't devolve into a miser-like attitude that economic efficiency is all that matters and we help people only to the extent we can see a buck in it.

We are - and will stay - a rich country. We can afford to educate ourselves well because to be educated is one of the joys of life, a benefit from being rich. And we should need no better reason for sharing our wealth fairly than that it's right thing to do.