Mixed motives for Hockey’s budget intransigence

Joe Hockey has many reasons - worthy and unworthy - for avoiding making any firm commitment on when an Abbott government would get the budget back to surplus.

Starting with the worthy ones, Hockey is perfectly justified in saying the outlook for the economy as it makes the transition to more normal sources of growth is far too uncertain, and the consequent forecasts and projections for the budget balance shown in Treasury's pre-election economic and fiscal outlook far too unreliable, to provide any sensible basis for such a commitment.

Everything Treasury said in the outlook about its uncertainty and the fallibility of its forecasts confirms the foolishness of treating the latest estimates as offering anything but the roughest of rough ideas of what the future holds.

What Hockey is not justified in doing is impugning the professional competence of Treasury - when it comes to guessing the future, the econocrats are at least as good as the rest - or implying it had been got at by its political masters. Nor is he justified in telling the punters that wrong forecasts equal economic mismanagement and profligate spending by Labor.

The second worthy reason for the Coalition parties to make no firmer commitment than their uncheckable promise to always do better than Labor is that, despite their fear campaign on the evils of deficit and debt, sensible fiscal policy tells us there's no urgency about getting the budget back to surplus.

When the Rudd government laid out its "deficit exit strategy" in its second big fiscal stimulus package in February 2009, it specified that the strictures it would impose on itself - to avoid more tax cuts and limit the real growth in government spending to 2 per cent a year - wouldn't take effect until the economy had turned up and was back to growing at its medium-term "trend" rate (3 per cent a year).

For as long as it seemed the economy had returned to growth at or near trend, it was reasonable to stick to those strictures and thereby do nothing to hinder the budget's automatic stabilisers in their role of returning the budget to surplus as the expansion proceeded.

With hindsight, however, it is clear growth has reached or exceeded 3 per cent only in one year - 2011-12 - since the global financial crisis hit in 2008-09. It was well below trend in the first three years. For the past financial year growth is now expected to be 2.75 per cent, falling to 2.5 per cent in 2013-14.

This below-par performance was concealed by Treasury's persistent over-forecasting of real growth. And that's before you get to its recent over-forecasting of the growth in nominal gross domestic product - and thus tax collections - because it underestimated the fall in export prices.

The point is that the bipartisan "medium-term fiscal strategy" simply requires governments to let the automatic stabilisers do their job of returning the budget to surplus without hindrance by explicit policy decisions.

You don't make the deficit worse - after any initial temporary stimulus - but nor are you required to hurry things along except to the extent that you're acting to reduce any structural - that is, longer-term - component of the deficit once strong growth has resumed, and such efforts won't be counterproductive ("pro-cyclical") as they've proved to be in Europe.

Of course, none of this absolves the Coalition from its obligation to show how it will pay for its election promises, with costings done by the Parliamentary Budget Office and consistent with Treasury's costing conventions - as applied to their Labor opponents - not fudged-up costings supposedly audited by some underqualified, little-known firm of accountants, as in the last election, nor some panel of retired worthies with no access to the multitude of data needed to cost programs with any accuracy.

And the unworthy reasons for avoiding any firm commitment on when an Abbott government would get the budget back to surplus? I can think of three. Because it's a safe bet the Coalition parties intend to put their debt-and-deficit rhetoric on the back burner as soon as they're back in power and the fear campaign has served its purpose.

Because, even in government, Tony Abbott is likely to prove an incorrigible populist with little interest in or sympathy for the precepts of rational economics. As is clear from the way he keeps departing from the agreed line in this campaign, Hockey, Arthur Sinodinos and Malcolm Turnbull would have an unending struggle trying to keep the boss up to the mark. He could easily prove worse than Kevin Rudd in fiscal indiscipline.

And, finally, because an Abbott government would have handicapped itself so badly on the tax side of the budget that fiscal responsibility would require a degree of continuing restraint on the spending side of which no flesh-and-blood government is capable.

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Budget forecasts for adults only

When Treasury and the Department of Finance issued their pre-election economic and fiscal outlook statement this week it had something written on the cover in invisible ink: Why don't you all grow up!

Although the figures in the PEFO ("pee-fo") for the forecast and projected growth in the economy and the change in the budget balance over the four years to 2016-17 were virtually identical to those in the Labor government's economic statement 11 days earlier - no surprise to anyone except conspiracy theorists - the words were quite different.

What Treasury issued was a kind of adults only version of the government's document, a rebuke to people who think knowing what the future holds is easy peasy and anyone who gets their forecasts wrong must be either incompetent or corrupt.

The Labor government was so unsophisticated in its understanding of the limitations of forecasting it took a Treasury projection of the budget balance in four years' time and raised it to the status of a solemn promise. No one working in Parliament House thought this a foolish thing to do.

The first thing Treasury does in the PEFO is stress that, while all forecasts are uncertain, the economy's transition to new sources of growth make these forecasts particularly so. It said the transition "may not occur as smoothly as forecast" twice on the first page.

Cop this for a product warning: "This uncertainty surrounding global growth prospects poses a risk to the terms of trade and nominal gross domestic product forecasts. There is also a risk that the anticipated fall in resources investment following its peak could be sharper than expected, especially around the middle of the decade. In addition, the transition to new sources of growth may not occur as smoothly as anticipated. Unexpected global or domestic developments could also generate further sharp movements in the exchange rate."

It's long been the convention to express forecasts as a "point estimate" - a single figure rather than a range. But quoting single figures gives the forecasting exercise an air of false precision which can mislead the uninitiated.

So Treasury has joined the Reserve Bank in showing the "confidence interval" surrounding its key point-estimate forecasts. It has examined the (lack of) accuracy of its forecasts over the past 13 years and used this to show its latest forecasts over a symmetrical range, with its point estimate the central forecast within that range.

Its central forecast is that real GDP will grow at an average annual rate of 2.75 per cent over the two years to 2013-14. So if you assume its forecast errors are similar to those in the past, and also assume its forecasts are just as likely to prove too high as too low, there is a 70 per cent probability that actual real growth will average somewhere between 2 per cent and 3.5 per cent (that is, the central forecast plus or minus 0.75 percentage points).

Its central forecast is that nominal GDP will grow at an average annual rate of 3.125 per cent over the two years. So there's a 70 per cent chance the actual rate of growth will average between 1.75 per cent and 4.5 per cent (central forecast plus or minus 1.375 percentage points).

Why is the confidence interval for nominal GDP so much wider than for real GDP? Because, to get to nominal, you also have to forecast the GDP inflation rate (strictly, the GDP deflator) and it's much more uncertain because it's heavily affected by the change in the terms of trade (export prices divided by import prices) and thus the prospects for world commodity prices.

Why is the GDP inflation rate forecast to be so small, just an average rate of 0.375 a year? Mainly because export prices are expected to fall a fair bit further.

Why does the growth in nominal GDP matter much? Because, as Wayne Swan never tired of pointing out, we live in - and pay tax in - the nominal economy; the real economy is just a (useful) concept.

It was because Treasury kept under-forecasting the rise in export prices that it kept underestimating the improvement in the budget balance in the early years of the resources boom. It's because it's been under-forecasting the fall in export prices that it's been overestimating the improvement in the budget balance in recent years.

Another aspect of the politicians' and media's incomprehension of the budget figuring is their failure to understand the difference between forecasts and projections. By government decision, the figures for the budget year and the first year of the forward estimates are forecasts - that is, Treasury's best guess on what will happen. But the last two years of the forward estimates are merely projections - that is, you assume it will be an average year and mechanically plug in the figures accordingly.

You assume "trend" real growth of 3 per cent, trend employment growth of 1.5 per cent, inflation at the middle of the Reserve Bank's target range - 2.5 per cent - and unemployment at what the econocrats consider to be its lowest sustainable rate (aka full employment), 5 per cent.

This makes it all the more foolish for the government to turn a mere projection of the budget balance in four years' time into a solemn promise, and for the rest of us to take it seriously.

It also means you can get some literally incredible jumps between the last forecast year and the first projection year.

For instance, between 2014-15 and 2015-16, the unemployment rate is supposed to drop from 6.25 per cent to 5 per cent, even though real growth stays unchanged at just 3 per cent.

Treasury uses the PEFO to show what it would have forecast for the last two years of the forward estimates had it not been required to use projections, and drops a big hint it will ask the "future government" to change the rules to four years of forecasts.

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City and country problems all demand higher taxes

At last we've settled on an election issue of substance: did Kevin Rudd use notes in the TV debate and was this against the rules? And that's not all: did he rustle his notes and, if so, was this deliberate or just a nervous mannerism?

The two leaders' aim in the debate was the same as their aim in this campaign: to make it to election day while giving as few commitments as possible about what they'll do in the next three years.

I wouldn't mind so much if they were trying to stay unencumbered, able to respond to any eventuality. But actually they're trying to create the illusion that everything they have planned will solve our problems without any price to be paid.

Tony Abbott keeps telling us about all the taxes he plans to abolish but not how he'll cover the loss of revenue, except to say he'll get rid of government waste. Sure.

In response to Rudd's embarrassing "cheap scare campaign" on the goods and services tax he assured us that "the GST is not going to change", but avoided answering a question on how long that guarantee would last.

By the end of the next day, however, the pressure had become irresistible and he ruled out changing the GST for as long as an Abbott government lasts. In modern campaigning, tough issues aren't debated, they're closed off.

And on when Sydney will get a second airport, both men are evasive. In the 40 years since Gough Whitlam asserted "you're getting Galston", successive governments have pushed the decision aside.

These guys touch on matters of concern to ordinary people's ordinary lives but they rarely get to grips with them. Consider the findings of the latest Ipsos Mind and Mood report on differences between the city and the country, Life in Two Australias. A series of 16 group discussions in Sydney, Melbourne, Tamworth, Townsville and Bunbury finds that, whatever their complaints, country people prefer the country and city people prefer the city, though country people do seem more effusive.

They see their lives as low-stress, with friendly faces, open spaces and manageable mortgages. It's a cleaner environment where their kids can get dirty. Parents feel their kids get great formal education but are also more rounded and grounded in their social and communication skills.

"Skinny-dipping, fishing, four-wheel driving, open fires and bartering were cherished aspects of a free-range, unconstrained regional lifestyle," the researchers, led by Dr Rebecca Huntley, report.

And the big drawback? "It is healthier to live in the country unless you're sick." Poorer access to good quality health services was a key disadvantage of regional centres, sending the sick onto long local waiting lists or down the highway in search of help in the city.

Although country participants felt they had a monopoly on community spirit, city people valued social inclusion and connection with their neighbourhoods. And though their green spaces and open places may be smaller, they're valued.

The high cost of housing and rising living costs were key motivations for considering a move to the regions. Country life looks attractive to stressed-out city residents, young families and retirees.

But could they leave family and friends? What about the horror stories of inadequate country health services? Would there be enough shops and enough entertainments to keep them amused? And would they be welcomed? "Rumours of gossip-laden, judgmental, close-knit social networks that could be hard to break into fed fears of potential social isolation," the researchers find.

How does this discussion of ordinary life fit with the preoccupations of the election campaign? Well, it's clear adequate healthcare and access to doctors is a major concern for country people.

But health is one of the issues being closed off. There's a lot more needing to be spent. But Labor is being pilloried for its increased spending (on health as much as anything) and the focus is on criticising tax increases, cutting company tax, abolishing new taxes and swearing never to increase old ones.

For city-siders, however, the big issue is roads and public transport. "The lengthy commute in bumper-to-bumper traffic is literally driving people out of our capital cities to regional Australia in hope of recovering wasted hours spent in the car each day," the researchers say. City drivers feel forced to take to their cars because of inadequate public transport, while country people envy their trains, trams, buses and taxis.

Ah, here we may have found a match. Although Rudd hasn't had much to say about roads and transport, Abbott says he hopes he'll become known as an infrastructure prime minister and reels off a list of city road projects he wants to fund.

Sorry, but I'm not convinced. The Coalition doesn't seem to have learnt what I thought everyone realised by now: building more expressways solves congestion only for long as it takes more people to switch to driving their cars.

The problem is reduced only by improved public transport. But Abbott would revert to the view that the feds don't finance urban public transport projects.

So leave it to the states. But they've just had their finances crimped by his promise never to repair the premiers' biggest but ailing source of revenue, the GST.

And both sides' belief that government debt is evil condemns us to a life of inadequate public infrastructure.

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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.

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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.

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THE (ECONOMIC) CASE FOR A MORE EQUITABLE AUSTRALIA

Gavin Mooney Memorial Oration (with Rev Tim Costello), Melbourne University, Wednesday, August 7, 2013

I didn’t know Gavin Mooney, but I do know that, unusually for an economist, he had a deep concern for fairness or, as economists call it, ‘equity’. So it’s highly appropriate that, in this the inaugural Gavin Mooney Memorial Oration, we address ‘the case for a more equitable Australia’. I want to talk about the economic case for a more equitable Australia. But before I do I want to enter a major caveat.

Why should we seek a more equitable Australia in which income and wealth and opportunity are shared more fairly between the top and the bottom? For no better reason than that it’s the ethical, moral, right thing to do. If it’s the moral thing to do - the thing that, for Christians, Jesus wants us to do, and most other religions and humanist ethical codes tell us we should do - we don’t need any supporting arguments. I’ve often heard the ethicist Simon Longstaff say that if you’re ethical in your business practices because you believe it’s good for business, you’re not being ethical at all. Ethics as a profit-making strategy isn’t ethics. One of the things I’ve learnt from my reading of psychology is that it’s always better to do things from intrinsic rather than extrinsic motives. It’s better to do things for their own sake - because you enjoy doing them or believe it’s your duty to do them - than because doing them brings you some sort of external reward - money, power, fame or status.

I’m often sorry when I hear people in noble occupations defending what they do with instrumental arguments. I’d like to hear more vice chancellors say they believe in increasing and spreading knowledge for its own sake, that a rich country like ours can afford to spend a far bit of its wealth on satisfying our insatiable human curiosity, that the better educated people are the more they can get out of life, even if they never put that education to use in the workforce, rather than arguing that investing in education is good for the economy. I’m sorry when I hear people in the arts arguing that the arts create many jobs. When we do this we’re giving in to the hyper-materialism of our age.

But having said that, I have to acknowledge that Tim is more qualified than me to make the moral case for a more equitable Australia - and he’s just done that - and as an economic journalist it’s more appropriate for me to make the economic case. So it may seem that I’m about to do what I just said other people shouldn’t do: argue that we should be more equitable because this would make the community better off materially. I actually believe that to be true - just as it’s true that spending more on education would make us all better off materially - but actually I’m going to make the mirror image argument: that making Australia more equitable wouldn't make us worse off.

Why am I mounting such a negative argument? Because there’s a widespread belief among economists and their fellow travellers that making Australia more equitable would leave the community worse off materially, that it would come at the cost of a lower material standard of living overall.

The longstanding conventional wisdom among mainstream economists is that ‘equity’ is in conflict with ‘efficiency’ - that is, the efficient allocation of resources so as to maximise the community’s material standard of living and foster economic growth. Economists are comfortable with objectives being in conflict because a key part of their expertise is knowing how such conflicts are resolved: by trading off one unit of equity for one for one unit of efficiency (or vice versa) and continuing to do this until you’ve achieved the particular combination of equity and efficiency that gives you maximum satisfaction overall. Once you’ve achieved that ideal trade-off you’ve achieved economic nirvana: equilibrium.

In practice, however, it’s worse than that. Economists specialise in efficiency, but not in equity. Their contribution to society is to explain to the community how to organise the economy in ways that maximise our utility or satisfaction from the production and consumption of goods and services, and how to keep our material standard of living improving every year. If you believe that efficiency and equity are always in conflict, so anything you do to improve equity will always be at the expense of efficiency, but you, as an economist, happen to specialise in efficiency, it’s easy to decide to focus on efficiency and ignore equity. After all, we live in an age of ever-increasing specialisation - which is actually a primary source of productivity improvement and thus our ever-rising material affluence. So you focus on efficiency and growth, and leave equity for others to worry about.

You bolster this decision by observing that, whereas efficiency is objective and measurable, equity is highly subjective; fairness is in the eye of the beholder. So you tell yourself - and anyone who asks - that you stick to the science and leave the value judgments to those more qualified, such as the politicians. (This would be fair enough, were it not for the fact that, in proffering their advice, economists rarely attach product warnings. Though the advertisers of patent medicines warn people to see a doctor ‘if problems persist’, economists don’t warn politicians to check with sociologists or prelates before they act on the economists’ advice.)

The problem is, if it’s not true that efficiency and equity are in conflict - or not always true - then the economists will be failing to advise politicians of cases where equity can be improved without any loss of efficiency - that is, failing to advise the community when there’s a free lunch to be had. And if, because of their lack of interest in equity as an objective, economists fail to draw attention to those cases where improving equity can lead also to improved efficiency, then economists are failing in their own specified role to maximise efficiency and failing to point out cases where we can kill two birds with one stone.

I’m sure there are plenty of cases where equity and efficiency really are in conflict. But I’m equally sure there are many cases - far more than we realise - where they aren’t; that there are delicious free lunches going begging and opportunities to increase efficiency that the efficiency experts themselves haven’t noticed because of this kink in their thinking.

Let’s start by looking at the limited case: where is the evidence that greater equity damages efficiency? The opponents of government intervention have been searching for years for cross-country or other evidence that developed economies with a bigger public sector (and thus a more redistributive tax and transfer system) have inferior records on economic growth. They haven’t found it. Nor have they found evidence that countries with a less unequal distribution of income between households have inferior economic growth. In his book, The Price of Inequality, the Nobel Prize- winning economist Joe Stiglitz observes that various European countries enjoy a standard of living much the same as America’s while doing much more to reduce income inequality than America does. So there’s little evidence we have to accept a highly unequal society to preserve an efficient, growing economy. Studies show the US has surprisingly low social mobility: few people with poor parents go on to have high incomes and, conversely, few people suffer a decline in income between generations. If you can stay rich in America without trying, and stay poor despite trying, it’s hard to believe this won’t lead to a long-term decline in the dynamism of the US economy.

So let’s move on to the evidence for the more positive case: that equity and efficiency can pull together, that reduced inequality can actually enhance efficiency and growth. There’s a growing amount of such evidence. But before we get to it I need to acknowledge the contribution of Gavin Mooney. One of his great research interests was in what health economists and public health medicos call ‘the social gradient’ or ‘the social determinants of health’. There is much evidence that the health of people with low socio-economic status is much worse than that of people with high socio-economic status. The obvious response to this evidence is to say that measures to improve the health of people on the bottom ought to lead to a very real improvement in their wellbeing. That’s the equity objective. But health, like education, is one of those things that are both a means and an end in themselves, an instrument as well as an objective. The better educated a population is, the more its labour is worth and the richer we can expect it to be. Similarly, the healthier a population is the more able it is to work and the richer we can expect it to be. So the more we do to improve the health of the bottom half, the more efficient the economy should be and the faster it should grow.

Stiglitz cites an IMF study finding that the less unequal a country’s income distribution is, the further apart its recessions are likely to be - that is, the less macroeconomic instability it’s likely to suffer. His book contains much similar evidence and arguments, but I want to refer to the work of one other American Nobel laureate, James Heckman, before I move my argument closer to home. Heckman’s work demonstrates the almost magical power that attending to the early childhood development of at-risk children has in reducing the likelihood of them getting into trouble with the police, dropping out of school, being in and out of employment and in and out of jail. It’s obvious that the success of such a program would do much to improve equality of opportunity, and it’s not hard to see it would also greatly improve the beneficiaries’ contribution to the paid labour force (not to mention the pressure on government spending).

The most obvious case of increasing equity also increasing efficiency is unemployment. We think it’s unfair to have people who want to work unable to find a job, not just because it leaves them with less to spend but also because we know the unemployed are particularly unhappy. Sure. But it’s also glaringly inefficient to have people who’re able to work lying around idle and not contributing to national production. Finding ways to get those people back to work would often make a far greater contribution to efficiency than many of the micro-economic reforms economists hanker after.

Two prominent - and now apparently bipartisan - policies in this campaign are seen as primarily about equity, but nonetheless should bring significant efficiency benefits. The first is the Gonski reforms to school funding, which are intended to increase the assistance able to be given to students suffering one form of disadvantage or another regardless of which school system they’re in. If this results in more young people gaining a better education, the value of their labour is increased as well as their degree of participation in the labour force. It’s a similar situation with the national disability insurance scheme. It can be expected to increase workforce participation and the acquisition of skills. And where unpaid carers with high skills are able to return to the workforce after being replaced by paid carers with lesser skills there’s obviously some increase in the skills of the workforce. According to the estimates of no less an authority than the Productivity Commission, the disability scheme could be expected to lead to an annual increase in real GDP reaching 1 percentage point by 2050.

Finally, in an issue that’s dear to my heart, there is growing evidence that organising work in the workplace in ways designed to increase the satisfaction workers derive from their work - by making sure you put round pegs in round holes, or having them work in teams, or giving them greater personal autonomy or a say in the way things are run - leads them to make a better contribution to the success of the firm. Since most of us are doomed to spend 40 hours a week working for most of our lives, it amazes me the populous hasn’t long ago insisted that work be made as satisfying as possible. The growing evidence that doing so would also increase efficiency makes it even more amazing.

The case for greater equity in Australia is fundamentally a moral one: we should do it because it’s the right thing to do. But the economic efficiency case for not making Australia more equitable is weaker than many economists assume. There is evidence we can increase equity in ways that don’t reduce efficiency. And if we look for them there are many ways we can reduce inequality and increase efficiency at the same time. Let’s do it.

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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.

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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.

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Economic problems the pollies don't notice

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Bowen's statement: fantasy for grownups

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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