Saturday, September 21, 2013

What's driving our dollar

The clouds over our economy got a bit darker this week with the news that the US Federal Reserve was in no hurry to begin "tapering" its quantitative easing.

This underlined the reality now dawning on the new Abbott government that the outlook for the economy is quite uncertain and, unless we're lucky, quite weak. It's certainly not a time when you should shift to a contractionary stance of fiscal policy because of some misguided desire to force the pace in getting the budget back to surplus.

But let's start with the Americans and their quantitative easing. "QE" is a form of economic stimulus - the sort you resort to when you can't stimulate the economy the conventional way by cutting the official interest rate because it's already close to zero.

It involves the central bank buying government bonds or other securities in the marketplace and paying for them by just crediting money to the sellers' bank accounts (a trick only central banks, the creators of money, can do).

The intention is that increasing the money in circulation encourages demand (spending) at a time when aggregate (economy-wide) supply exceeds aggregate demand, with workers lying idle and firms operating well below full capacity.

Some people, remembering stuff their heard in the 1970s and '80s, worry that "printing money" causes inflation. It does if it causes demand to exceed supply - as would have been the case back then - but it doesn't when demand is a lot weaker than supply, as has been the case in the North Atlantic economies since the global financial crisis.

Even so, the Fed has been warning it will start cutting back (tapering) the amount of its continuing monthly purchases of bonds as it sees the economy strengthening, just to be on the safe side.

What happened this week was the Fed's decision that the economy wasn't yet strong enough to start the tapering. It was worried that recent figures for employment weren't as strong as expected.

It was also aware that the congressional deadlock over the budget was bringing about cuts in government spending and increases in taxes that exerted significant contractionary pressure on the economy. And another confidence-sapping battle between the President and Congress was brewing.

So how do our interests fit into this? Well, this is where it gets tricky. It's not bad news that, in the face of a weaker-than-expected economy, the Fed decided not to start withdrawing monetary stimulus. It's in our interests for the US economy to be as strong as possible.

What is bad news is that the US economy isn't strong enough for the tapering to begin. That's because one of the ways quantitative easing stimulates demand is by putting downward pressure on the country's exchange rate.

And anything that puts downward pressure on an important currency like the US dollar puts upward pressure on our dollar. What's stimulatory for them is thus contractionary for us.

As we've been reminded only too well in recent years, a high dollar reduces the international price competitiveness of our export and import-competing industries, causing us to produce less than we otherwise would.

From our perspective, our dollar has been high because of the resources boom: the high prices we were getting for our exports of mineral and energy and because of the foreign capital flowing in to finance all the investment in new mines and natural gas facilities.

With export prices having fallen a fair bit over the past two years, we expected to see our dollar come down and stimulate production in manufacturing and tourism.

For a long time nothing happened. It started falling in mid-April, but still hasn't fallen as far as it probably should given the size of the fall in export prices.

It took us too long to realise what the problem was: quantitative easing in other countries, particularly the US. Our dollar couldn't come down because it was being held up by the weak greenback.

This is a reminder that the exchange rate is a relative price: the value of our currency relative to the value of some other country's currency. So it's affected both by developments in our economy and developments in theirs.

It was when the Fed started making noises about tapering its quantitative easing that the currency market began anticipating this occurrence, pushing the greenback up and allowing our dollar to fall. Between mid-April and the end of July the Aussie had fallen about 14 per cent.

But this week's surprise announcement from the Fed saw the greenback drop against most currencies, including ours. Last time I checked, the fall since mid-April had narrowed to 10 per cent.

It's always dangerous to assume some change of direction that's just happened in financial markets will continue or even just not be reversed. But this week's events do suggest that the further fall in the Aussie dollar we've been hoping for is now less likely because the phasing out of America's quantitative easing is now further away.

Our present problem is familiar to you: with the resources boom's net contribution to growth now turning negative, we need the rest of the economy - particularly investment in new housing, and non-mining business investment - to take up the running. A decent fall in the dollar would do a lot to help stimulate the non-mining economy.

The other hope is for a turnaround in business and consumer confidence following the change of government.

The main indicators of confidence have improved since the election, with the Westpac-Melbourne Institute index of consumer sentiment jumping 4.7 per cent this month as Coalition voters' confidence leapt 19 per cent and Labor voters' fell 10 per cent.

But it's far too soon to say whether this improvement in the indicators of business and consumer confidence will translate into a significant improvement in actual economic activity and employment.
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Wednesday, September 18, 2013

The transformation of Tony: can you believe it?

On Classic FM last month they used to play an ad with just a second or two of arguing politicians before the kicker: "Election? What election?" Then on with the soothing music. It was a bit naughty for the ABC, but it was just what many people were thinking.

According to group discussions conducted in the last week of August by the Ipsos research firm for its Mind and Mood report, the consensus from participants' lounge rooms around the country was loud and clear: "We are sick of this election campaign and we just want it over with."

When the groups were invited to discuss what mattered most in people's lives, politics was barely mentioned. When the researchers did raise the election, participants often rolled their eyes or groaned.

Many thought this was "one of the worst elections we've ever had".

But I remember people complained a lot about the 2010 campaign. What doesn't seem to have occurred to people is that it's hard to get excited about a contest when you know who's going to win it. And with the media's incessant quoting of opinion polls, no one could have been in any doubt. If the media want their election coverage to excite interest, they're fouling their nest.

But "one of the main reasons participants felt disconnected from politics and the election was their dissatisfaction with both of the major parties' leaders," the report says. "Regardless of whether their values were more closely aligned with Liberal or Labor (or the Greens) few people had positive things to say about either Kevin Rudd or Tony Abbott."

There was also disappointment with how the campaign had been run and, in particular, the lack of debate about policy, we're told. Many complained the Liberal and Labor campaigns focused on "slagging off" their competition instead of explaining policies.

Participants were tired of the mud-slinging and personal attacks launched directly by the major parties' leaders and felt that both lacked the charisma and vision required to inspire and help them connect with politics.

To this end, many hoped the election would bring an end to minority government, the constant bickering and lack of stability that has characterised the last few years of Australian politics, the report says.

But I say all the bickering and seeming lack of stability arose not from minority government as such, but from Abbott's reaction to it, which was to assume government could fall into his hands at any moment and maintain a stance of total opposition to everything.

The past three years have left a nasty taste partly because of Julia Gillard's unpopularity and Labor's constant feuding, but mainly because Abbott ran a three-year election campaign of politicians eternally at each other's throats.

But did you notice the way he transformed himself for the campaign proper? The man who'd run the highly effective but dishonest scare about the terrible effects of the carbon tax and - as we only now discover - a quite insincere scare about debt and deficit, became the man professing to be "embarrassed" by Rudd's scare campaigns on the Coalition's supposed plans to raise the GST and to "cut, cut, cut" government spending.

And by the campaign proper the man who wrote the book on negativity was accusing Rudd of being "so negative".

In government, the Transformation of Tony has continued. The bruiser and attack dog of opposition now promises a "stable and sensible" government that brings "stability and predictability" and is "methodical, measured, calm" in discharging its duties.

Huh? At one level he's a man who knows he has to mend his ways; that successful prime ministers don't act the way he did as opposition leader. He understands people's longing for greater stability and certainty than they experienced over the past three years.

At another level it's what every incoming Liberal PM says. Malcolm Fraser wanted to "get politics off the front page". John Howard wanted to make us "comfortable and relaxed". They dream of returning us to a Menzian torpor.

Historically, it's what the Liberals stand for. Labor is the eternally dissatisfied party of "reform" while the Libs are the conservatives, satisfied with the world as is and trying to stave off disruptive change as long as possible.

A truth our politicians too often forget is that most of us hate change. I confess Abbott's vision appeals to me enormously. Should the 24-hour media cycle slow down and politics become less thrill-a-minute I'm sure I could still find plenty to write about.

But can Abbott attain this degree of stability and tortoise-like approach to progress? He's always struck me as a man who makes plenty of new year resolutions but never keeps 'em for long.

The sad truth is steadiness is contrary to the spirit of our age. Things have sped up as technology and globalisation have opened us up to changing pressures originating anywhere in the world.

And the non-Labor side of politics has changed from conservative to radical. It's as much addicted to "reform" as Labor. Whereas once it resisted changes proposed by those lower on the ladder, today it wants to reclaim lost ground.

Abbott's promise of "no surprises, no excuses" will be the first he has no choice but to break. As Harold Macmillan apparently didn't say, "Events, dear boy, events".
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Monday, September 16, 2013

How business lobbies to block tax reform

There are a lot of people moving office in Canberra, thanks to the election. But not all of them are politicians. There is a parallel changing of the guard among the lobbyists - a change that will have far more effect on what happens to us in the next three years than most people realise.

As has been well reported by Matthew Knott, of Crikey.com.au, Liberal-aligned lobbying firms - full of former politicians and staffers - are expanding their presence, while Labor-aligned firms are downsizing.

These people are selling access and influence with the side of politics that happens to be in power.

Since businesses pay big money for the assistance of these people - many of them seeking to cash in on their former lives in politics - we must assume it makes a difference, that businesses represented by someone of the same persuasion as the government get a more sympathetic hearing.

If so, the formal lobbying process plays a bigger part in our governance than it suits the politicians to admit or the media to keep us informed about. Lobbyists prefer to practise their dark art without the glare of publicity and, for the most part, the other players respect their privacy. Most obliging of them.

Of course, there are two classes of lobbyists in Canberra: the firms of influence-pedlars we've been discussing, but also the national peak bodies representing business in general, particular industries, small business and even many non-government organisations.

The peak bodies' lobbying efforts - while they no doubt have their private, let's-not-talk-about-it side - are a lot more overt, with the outfits issuing an unending stream of press releases and submissions, and their spokespeople seeking airtime for their reactions to a Reserve Bank decision to raise interest rates, the budget, the election of a new government, or an absolutely crippling rise in the minimum wage.

My guess is that, when the peak bodies are engaged in a major campaign, they quietly enlist additional assistance from the professional lobbyists.

Much of the time the peak bodies are lobbying for their own "reforms": a cut in the rate of company tax, changes to Labor's Fair Work Act, a cut in the top rate of income tax and increase in indirect taxes, and so forth.

But I think they're at their most effective - and most insistent - when they're trying to block or seriously modify some change initiated by the government. Consider the chequered history of the departed Labor government.

We could start with the business lobbyers' success in getting Labor's original emissions trading scheme watered down and, for all we know, the success of some in egging on the Coalition's climate-change deniers, who persuaded the parties to ignore the "mandate" Labor had to introduce such a scheme. So much for mandates.

But the most spectacular blocking effort must surely be the success of three of the world's most profitable mining companies - acting under the cover of the Minerals Council of Australia - in knocking off the original resource super profits tax and getting it replaced by the badly designed minerals resource rent tax, which the Coalition is about to abolish not long before it starts raising significant amounts of revenue.

Labor's handling of the mining tax was abysmal, but much of the big miners' success (which also came at the expense of the small miners) is owed to Tony Abbott's willingness to oppose the tax for reasons of short-term political gain.

Non-mining businesses have yet to twig that the miners' success will come at their expense. With the miners soon to be so undertaxed, the scope for a further cut in company tax has gone. It's called opportunity cost.

More recently, we have the success of the financial services lobby in winning a multi-year exemption from further reforms to superannuation (achieved, it's said, because of the lobby's threat to launch an election advertising campaign against whichever side of politics failed to give it the exemption it was demanding).

This is not to mention the success of the medicos in getting a delay in the clampdown on abuse of the self-education tax deduction and the success of the novated leasing industry in getting Abbott to preserve the company car tax rort.

If you saw this sorry saga as a testament to Labor's political ineptitude you wouldn't be wrong. But there's another lesson to be learnt: the more business looks the other way while particular industries frustrate governments' efforts to reform the tax system, the less likely it becomes that business in general will get the changes it's seeking.

Tax reform doesn't grow on trees.
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Saturday, September 14, 2013

Death of man who inspired the emissions trading scheme

The man who first thought that governments should auction off rather give away the rights to such things as broadcast spectrum or taxi licences, and who started the thinking that led to the invention of emission trading schemes, died last week at the age of 102.

He also inspired the joke economists tell each other as a warning against reading too much into statistics: "If you torture the data long enough, it will confess."

He was British-American economist Ronald Coase (rhymes with rose), of the University of Chicago, who in 1991 was awarded the Nobel prize for his trouble.

The first of his discoveries came in 1937 and launched a whole sub-field of economics, but now seems pathetically obvious. He asked why firms exist. Why do capitalists employ people to make or do lots of things for them, when most of those things could be bought from the market?

Why are many of the things produced by a "market economy" actually produced inside firms - some of them employing many thousands of people - where employees have to do as they're told by the boss and the rules of the market don't apply?

His answer was that buying things from others in the marketplace involved hidden costs, which he dubbed "transaction costs" - the cost of finding the best deal, checking quality, negotiating a price, writing a watertight contract and then, if necessary, enforcing that contract.

Business people would do things "in house" whenever this was cheaper than incurring all the transaction costs involved in buying from the market. (But once you start thinking like that, it eventually occurs to you that there will be times when it's cheaper to "outsource" the provision of services you formerly provided in-house.)

In a paper on the US Federal Communications Commission, written in 1959, Coase argued that the transaction costs faced by the commission in deciding which of the many applicants for a broadcast licence would make the greatest contribution to the economy were impossibly high.

But this did not justify the commission continuing to give away licences to whomever it saw fit. It would be better to replicate market conditions by auctioning the licence to the highest bidder. This way, the licence would go to the firm most likely to put the licence to its "highest-valued use".

Do you see how this led to the invention of the tradeable permit? Say the government is trying to limit to a certain level the catching of a particular type of fish, or limit emissions that cause acid rain, or those that cause climate change.

It issues permits for firms to catch or emit up to that level. Because this level is lower than the market would otherwise produce, it has thereby increased the item's "scarcity value", allowing firms with permits to get away with charging a higher price.

If it gives the permits away to firms, it's effectively allowing them to levy a tax on their customers. If it auctions the permits, it's ensuring the proceeds of the disguised tax are collected by the taxman.

The firms that get the licences by bidding highest can be expected to pay no more than allows them to continue profitably producing whatever it is. They'll also have a monetary incentive to find ways to continue producing their product while generating fewer emissions.

And by allowing firms to trade their permits - say, to sell any they discover they don't need - you increase their incentive to find ways to reduce their emissions, as well as ensuring the burden of reducing emissions is shifted to those firms that can do so at the lowest cost.

But Coase's greatest claim to fame came from a paper he wrote in 1960, The Problem of Social Cost, which became the all-time most cited paper by other academic economists and made him the darling of libertarians and free-market conservatives.

Social costs - also known as "negative externalities" - are costs imposed on third parties by transactions between people in the marketplace. Say I run a factory that imposes a lot of noise on my neighbours, emits fumes and puts gunk into the local river. Since this polluting costs me nothing it represents costs borne by the community, not by me and my customers. It's a cost that's "external" to the market.

What should governments do about this problem? The traditional answer was for them to protect the victims of this action by imposing restrictions or obligations on the perpetrator.

But Coase argued that, simply by clarifying the property rights involved, governments could leave it to the affected parties to negotiate a satisfactory solution. Again, the solution could be left to the market.

What's more, this ability to reach a privately negotiated solution meant it didn't matter to which side the government awarded the property rights. The libertarians loved this so much they called it the "Coase theorem".

What they liked was that it appeared to justify a greatly reduced role for governments in solving environmental problems. That it would also favour the rich and powerful was, of course, purely coincidental.

Over the years, however, Coase made it clear the libertarians had taken him out of context. For one thing, he'd argued that to whom you awarded the property rights made no difference from the perspective of economic efficiency. Obviously, it made a big difference from an equity or fairness perspective.

And his theorem had been based on the explicit assumption that the transaction costs involved in negotiating a solution were negligible. Not surprisingly, the man who had discovered transaction costs thought that, in the real world, transaction costs would be significant and often prohibitive.

Is it easy for all the people affected by a factory's pollution to get together and negotiate a satisfactory solution with a rich factory owner? Sounds to me like a case for government intervention.
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Wednesday, September 11, 2013

A lot of politics is unconscious pre-judgment

At last. God's in his heaven and all's right with the world. The rightful rulers of this country are back in charge, so now things can only get better. You think I'm joking? I'm not.

There's an American psychological test called the implicit association test which asks people to divide nice words and nasty words, black faces and white faces, into two categories and do it as fast as they can.

When journalist Malcolm Gladwell, author of Blink, tried the test he was so dissatisfied with his score he did it over and over, trying to improve his results. Why? Because he's half Jamaican - with a fabulous afro haircut - but the test revealed him to be unconsciously prejudiced against black people.

It turns out more than 80 per cent of all those who have taken the test were found to have "pro-white associations".

Gladwell explains our attitudes towards race and gender operate on two levels. We have conscious attitudes, things we choose to believe, which we use to direct our behaviour consciously. But the test measures our unconscious attitudes, "the immediate, automatic associations that tumble out before we've even had time to think". Such unconscious attitudes affect our behaviour without us realising it.

I believe something similar operates in our unconscious attitudes towards the two main political parties. We see the Liberals - the party of the bosses - as the party best suited to run the country.

Sometimes enough of us feel sufficiently rebellious to install Labor - the party of the workers - but this leaves many of us uncomfortable and yearning for the return of the masters. And when, sooner or later, it becomes clear Labor isn't doing well, no one is terribly surprised and we rush back to the security of our pater familias.

You don't understand anything about the underlying forces of Australian politics until you understand that.

It applies particularly to the economy. For decades pollsters have asked people which side of politics is better suited at managing the economy. And for decades the almost invariable answer is the Coalition.

There was a time during the term of the Hawke-Keating government when the economy was doing well and Labor was ahead on this question. But such times are the exception. Normally, Labor judges its success just by the extent to which it has narrowed the gap with the Libs.

It follows that the more the economy is seen as the dominant issue of federal politics - as it has been since Gough Whitlam's day - the more the Libs are seen as the natural party of government.

No one believes this more fervently than business people, of course. Business is always uncomfortable with a Labor government, but the Rudd-Gillard-Rudd government proved much less adept at maintaining good relations with business than the Hawke-Keating government.

So much so that the economist Saul Eslake has noted "the extent and depth of antipathy among the business community towards the present [Labor] government - which goes way beyond the normal inclination of most business executives or owners towards centre-right governments".

A big part of the problem was Labor's resort to the language of class conflict, starting with its decision to rename the original mining resources rent tax as the resource "super profits" tax.

New governments always enjoy a honeymoon with the electorate and a lift in business and consumer confidence. But this time it's hoped the turnaround in business confidence will be big enough to lead to a recovery in non-mining business investment, which has been weak for several years.

The resources boom and its high dollar, the end of the housing credit boom and the return of the more prudent consumer, and the continuing digital revolution mean that, although the economy has been travelling well enough overall, various industries have been hard hit by "structural change".

Most of these structural pressures are beyond the influence of government policy. That's particularly true of retailing, which includes a lot of small businesses and has been doing it especially tough.

The temptation for hard-pressed business people to blame their troubles on a Labor government has been irresistible. The change of government will make them a lot happier. And the more confident business is about the future, the better it's likely to do. The test will come when businesses realise their underlying problems haven't gone away.

Business people are usually highly critical of anyone seen to be "talking down the economy". But, we've learnt, this ethic applies only when the Coalition is in government. Tony Abbott and Joe Hockey were talking the economy down for at least three years, and many business people were publicly agreeing with them.

Of course, the assumption that Liberal governments always manage the economy well - that, in Abbott's revealing phrase, it's in their DNA - is wrong, just as the assumption that Labor governments are always bad at it is wrong.

The hope that all our problems will evaporate now the good guys are back in charge is wishful thinking.

But that doesn't stop our deeply held assumption to the contrary - an assumption shared by both Liberal and Labor politicians - from having real effects on our behaviour. One of the surprising truths of economics is that, to some extent, our expectations are self-fulfilling.

And already the budget and boat-people crises are over.
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Monday, September 9, 2013

Big change in party, little in policy

Coalition supporters rejoice! The evil incompetents have been banished and the good guys are back in charge. But don't get too excited because by the time we reached polling day many illusions about the difference a change of government would make had been shattered.

A standard delusion of election campaigns is that the Coalition portrays itself as standing for lower taxes, higher spending and lower budget deficits.

And Tony Abbott seemed to be cutting taxes big time, abolishing the carbon tax and the mining tax and cutting the company tax rate to 28.5 per cent.

But now we finally have the Coalition's full costings we see how far the reality falls short of the headline.

Its tax cuts will cost about $20 billion over four years (in cash terms), but its offsetting levy on big companies and reversal of Labor tax breaks - mainly on superannuation and small business - will claw back about $14 billion over four years.

And that's before you count the unlegislated Labor tax increases Abbott will put into law - including the increases in the Medicare levy and cigarette duty, and the new tax on bank accounts - worth about $28 million over four years.

Don't sound like lower taxes to me.

But surely the most disillusioning thing for Liberal true believers is the way five years of railing against Labor's utterly wasteful spending, never-ending budget deficits and soaring debt levels was simply cast aside over the course of a five-week campaign.

When, just before the campaign began, Labor was forced to reveal the deficit would be worse before we returned to surplus in another four years' time, the Libs proclaimed this a ''budget emergency''.

But then, just two days before polling day, they revealed their response to this emergency, which turned out to involve a net reduction in the cash deficit of just $6 billion over four years. On Treasury's projections, cumulative future deficits of a further $55 billion will now be a mere $49 billion and the return to surplus not a day earlier. Yippee.

Let me be clear: I wholeheartedly agree with the Liberals' last minute pull-back from resort to fiscal austerity. But then I was never taken in by their five years of frightening the fiscally illiterate.

What's supposed to be next on the agenda of a new government is a first look at the books, the amazed discovery it's all much worse than their predecessors let on, and the regretful announcement that this fiscal crisis necessitates a huge round of cost-cutting and the breaking of ''non-core'' promises.

Sorry, this ain't gunna happen, either. Why not? Mainly because Peter Costello's charter of budget honesty and, in particular, his instigation of the econocrats' pre-election economic and fiscal outlook statement was specifically designed to ensure he was the last treasurer able to pull that stunt.

If you've read the PEFO you've already seen the books.

But Abbott is further locked in by his repeated resolutions not to break his promises. He's even promised to let the deficit blow out rather than break a spending promise.

Labor claimed the planned ''commission of audit'' will be used as the vehicle for big spending cuts, but this was just its retaliatory scare campaign.

All past Coalition audits have been performed by purist economic rationalists who make radical recommendations no government would dream of accepting.

These and other promised inquiries (44 in Abbott's case) are just a device to get party hard-liners off a Coalition leader's back before elections.

There are just three main respects in which Abbott's policies are significantly different to Labor's.

First, the redistribution of the burden of taxation and the benefit of government spending against the Labor (and, for that matter, National Party) heartland and in favour of the Liberal heartland.

Second, the move from a market-based response to climate change to a pretend response. The campaign revealed a cap on ''direct action'' spending that means Abbott's professed bipartisan commitment to a 5 per cent reduction in emissions by 2020 is a sham.

Third, a marked improvement in business confidence now the socialist hordes have been vanquished.

This is the one delusion that remains from the rubble of an election campaign by the Liberals' most populist and least rationalist leader in a generation.

Fortunately, its delusory nature shouldn't stop it giving the economy a genuine boost as business ends its three-year-long dummy spit.

Today's return to real life will end one more illusion that accompanies every campaign: that it's governments who do most to manage the economy not the unchanging econocrats of the Reserve Bank.

There could be no more powerful reason why the change of government will change surprisingly little.
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Saturday, September 7, 2013

Little progress in economy's transition

With the election campaign supposedly fought mainly on economic management, it's surprising this week's figures for growth in the June quarter got so little attention. So what shape is the economy in as it looks like being handed over to a new government?


According to the Bureau of Statistics' national accounts, it's not doing well, but nor is it doing particularly badly. Real gross domestic product grew just 0.6 per cent in the quarter and 2.6 per cent over the year to June.

This is a touch better than many economists were expecting, but it's well short of our ''trend'' growth rate of 3 per cent a year. According to the figuring of Paul Bloxham, of the HSBC bank, we've slowed from an annualised rate of 3 per cent in the second half of last year to an annualised 2.3 per cent in the first half of this year.

This is too slow to generate sufficient additional jobs to employ the growing labour force and prevent unemployment from rising. Unemployment's gone from 5.4 per cent to 5.7 per cent of the labour force over the seven months to July.

The problem - as everyone must know by now - is that we're engaged in a difficult shift from growth led by mining to growth led by the rest of the economy as the resources boom goes through a ''phase shift''.

And, as Reserve Bank governor Glenn Stevens has reminded us, the transition is being made more difficult by the end of the long-running housing credit boom, which has prompted households to return to their relatively high rate of saving and therefore allow their consumption spending to grow no faster than their incomes.

This week's accounts show little sign we've got far with the transition, making it fortunate we're still getting some support from the resources boom as it moves from its investment phase to its production and export phase.

Investment spending by the mining sector looks to have fallen about 3 per cent in the quarter, but increased mineral exports do most to account for the 1.3 per cent growth in the volume of exports in the quarter.

With reducing mining investment also meaning fewer imports of mining equipment, this was sufficient to mean ''net exports'' (exports minus imports) had no net effect on growth during the quarter. (Over the financial year, export volume growth of 6.4 per cent and a fall of 1.8 per cent in import volumes meant net exports contributed a huge 1 percentage point to the overall growth of 2.6 per cent.)

Note that increased stockpiles of minerals did most to account for a rise in the levels of business inventories, which contributed 0.2 percentage points to growth during the quarter.

Note, too, that our terms of trade were steady in the quarter, implying no further fall in mining export prices.

The story on growth in the non-mining economy isn't as good. Consumer spending grew by 0.4 per cent for the quarter, which contributed 0.2 percentage points to overall growth. (Over the financial year, consumer spending grew 1.8 per cent, contributing 1 percentage point to overall growth.)

This growth is better than implied by the very weak monthly figures for retail sales (which account for only about a third of total consumer spending), mainly because of strong growth in purchases of services and, particularly, new cars.

Even so, its growth is well below trend consumption growth, which should be about 3 per cent a year.

With the household saving ratio roughly stable at a little more than 10 per cent of household disposable income, this tells us disposable income must also be growing at well below trend.

Why? Because its growth is not being bolstered by a lot more people getting jobs and because wage increases aren't as high as they were.

Is slower wage growth a bad thing? It may not sound wonderful, but it is giving the Reserve Bank confidence inflation will stay low notwithstanding the likely rise in import prices following the fall in the dollar. So it has permitted the Reserve to cut interest rates further.

Turning to the other main components of non-mining growth, home building and alterations fell by a surprising 0.6 per cent in the quarter.

But though the housing market is hardly rip-roaring in response to the present very low interest rates (another consequence of the prudence that's followed the end of the credit boom), it is recovering, and home building grew by a reasonably healthy 4 per cent over the year to June.

Non-mining business investment seems to have shown no growth during the quarter, which is a disappointment. We must hope the expected change of government will give business a bit more confidence to take advantage of low interest rates and the still-low cost of imported capital equipment.

Despite all the talk of cuts, Kieran Davies, of Barclays bank, calculates the public sector grew by 1.2 per cent in the quarter.

Though GDP per hour worked improved by just 0.2 per cent in the quarter, it's up by 1.8 per cent over the year. That's pretty much in line with trend - a far cry from the earlier talk of a productivity crisis.

Since much of the earlier apparent weakness was explained by the investment phase of the mining boom (many workers employed building new mines and facilities from which nothing was being produced), the more recent improvement is no doubt partly explained by more of the mines coming on line.

The trade-exposed sector's difficulty coping with the high dollar - which does much to explain the weak growth of the non-mining economy - probably helps explain a bit more of the improvement.

People have trouble understanding that productivity gains tend to come from pain rather than pleasure.

But let's not worry about that. Provided government changes hands this weekend, all our economic problems will evaporate within days.
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Wednesday, September 4, 2013

Why Abbott wouldn't be a great cost cutter

If Tony Abbott wins the election would he "cut, cut, cut" to fill the "$70 billion black hole" needed to cover the cost of his election promises, as Labor repeatedly claims? Would he follow the Europeans in adopting austerity policies, as others claim?

No. Why not? Because the man who'd be his treasurer, Joe Hockey, isn't that stupid and Abbott isn't that committed.

Let me make a fearless prediction: should the Coalition win the election, we'll hear precious little more about the evils of "debt and deficit".

While Labor was in power, Abbott and his colleagues exaggerated the significance of the size of the budget deficit and the level of the public debt because this was the only way to disparage the economic record of a government that had - with much help from the Reserve Bank - done surprisingly well.

But once the Coalition was back in power its need for fear-mongering about debt and deficit would disappear and it would face the same struggle to get the budget back to surplus that Labor faced.

Whenever it was challenged about its slow progress it would blame Labor but, apart from that, it would prefer to talk of other things.

How can I be sure? Mainly because Abbott's been backing off already. He used to say he'd get the budget back to surplus in "year one". Now his promise is merely that "by the end of a Coalition government's first term, the budget will be on track to a believable surplus" and "within a decade" the budget surplus will be 1 per cent of gross domestic product.

Only "on track" after three years? And "within a decade"? That's three elections away.

But also because the Libs have form on this sort of scare campaign. While John Howard and Peter Costello were in opposition in 1996, they drove a "debt truck" around Australia to ensure every "man, woman and child" knew how much they owed as their share of the nation's foreign debt. In government, however, they never mentioned the foreign debt again.

But can they get away with going cold after having made so much fuss? Well, the Republicans in America have been doing it for years. Their attitude is simple: budget deficits aren't a worry when they're being incurred by Ronald Reagan or the George Bushes, but they're a terrible worry when they're being racked up by Democrats like Barack Obama.

My guess is that, for the most part, those who've been most concerned about our supposedly soaring debt are those who'd naturally vote Liberal. They're really saying: "I'd feel a lot more comfortable about the budget if only the Libs were in charge of it."

Well, if Abbott wins, they would be. And that would be a signal to many people to stop worrying and leave everything to that nice Mr Hockey.

Hockey, by the way, has said several times that they wouldn't risk worsening unemployment at a time when the economy is fragile by pursuing policies of austerity - that is, by cutting spending or raising taxes by a lot more than is needed to cover the cost of their promises, in an attempt to reduce the budget deficit faster than would happen automatically as the economy strengthens.

As the Europeans have demonstrated, trying to force the pace while the economy is weak is counterproductive. It pushes the economy back into recession, actually making the deficit worse rather than better. So I don't have any trouble believing Hockey when he says he wouldn't be so foolish as to try it here.

Labor's claim that Abbott's election promises have created a $70 billion black hole he will need to fill with spending cuts is a wild exaggeration. It's been debunked by several fact-checking outfits.

But Kevin Rudd, Penny Wong and Chris Bowen haven't skipped a beat in repeating this false claim.

So don't for a minute imagine all the scare campaigns, dishonesty and dissembling is limited to one side. If you're tempted by such thoughts you've allowed partisanship to cloud your thinking.

The fact remains, however, that the Coalition is delaying until almost the last moment before revealing the full list of spending cuts needed to pay for its promises.

What's it got to hide? Well, maybe it has a few nasties it's hoping won't get too much attention before the poll, but it's just as likely it's worried about making some mistake in its figuring - in this area oppositions are at a huge disadvantage relative to governments - that Labor could use to damage its credibility.

An Abbott government would be looking for budget savings - just as Labor has been for several years - and would probably be more inclined to cut spending than end tax breaks.

Its first budget, in particular, would be a tough one, including various unpleasant measures that weren't contrary to its promises but many people weren't expecting. Its primary purpose would be to replace Labor's pet programs with the Coalition's pet programs.

But Abbott has made so much fuss about restoring our trust in politicians that I don't expect he'd follow Howard in using his first budget to break a lot of "non-core" promises.

He'd end up breaking many promises, of course - because "no surprises, no excuses" is a promise no honest politician would make - but not at first. And, like Howard, he doesn't have the stomach for genuinely smaller government.
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Monday, September 2, 2013

Why taxes would rise under Abbott

Election campaigns have become works of fantasy where, to enter the spirit of things, you have to suspend disbelief. And the greatest unreality this time is Tony Abbott's claim the budget can be returned to surplus in the coming decade while taxes go down, not up.

To most people the idea of permanently paying less tax is hugely attractive. And Abbott is promising to abolish the carbon tax and the mining tax, cut the company tax rate by 1.5 percentage points and abandon Labor's plan to end tax concessions for company cars. All this would cost about $28 billion over four years.

So what reason is there to doubt he would deliver a lasting reduction in taxes? Simply his promise to get the budget back to surplus - plus the knowledge government spending is set to grow strongly in the next decade.

To return to surplus and to do it while avoiding growth in tax collections would require a literally unbelievable degree of spending restraint.

Remember, though it gets little notice, Abbott is also promising to impose new taxes, increase taxes and eliminate tax breaks. These are partly to help cover the cost of the taxes he's getting rid of and partly to help pay for his new spending promises.

He's proposing a 1.5 per cent levy on big companies to cover the net additional cost of his paid parental leave scheme and a 0.5 percentage-point increase in all rates of income tax (aka the Medicare levy) to help cover the cost of the national disability insurance scheme (both raising $16 billion over four years).

To help cover the cost of abolishing the mining tax he's proposing to save $4.7 billion over four years by cutting business tax breaks: ending the instant asset write-off, removing accelerated depreciation for motor vehicles, ending the phase-down of interest withholding tax on financial institutions and ending the "tax loss carry-back".

Also to help cover the cost of abolishing the mining tax he proposes to save $3.7 billion in four years by effectively increasing the superannuation contributions tax for those earning up to $37,000 a year, and save $1.6 billion in four years on no-longer-forgone super tax breaks by delaying for two years phase-up in compulsory employer contributions.

And all this is before we get to Labor's as-yet-unlegislated tax rises, which Abbott has quietly indicated he would proceed with: extra revenue of almost $10 billion over four years from measures to "protect the corporate tax base", cut research tax breaks, increase cigarette tax and impose a levy on savings accounts.

When you see the list of tax hikes that accompany Abbott's grand tax-cutting gesture, it doesn't exactly inspire confidence he could keep taxes down in a way none of his predecessors has managed to.

And when you realise that - according to the earlier reckoning of Saul Eslake, of Bank of America Merrill Lynch - his election promises involve extra government spending of almost $15 billion over four years, it doesn't inspire confidence he could achieve the herculean spending restraint needed to get the budget back to surplus as well as keep taxes down.

The medium-term projections in Treasury's pre-election economic and fiscal outlook, about which I suspect we'll be hearing a lot more after the election, demonstrate how challenging the budget task will be in the coming decade.

According to the projections, if the government elected this Saturday sticks to Labor's strategy of limiting average real growth in spending to 2 per cent a year and not allowing tax collections to exceed 23.7 per cent of gross domestic product, the budget surplus will recover to 1 per cent of GDP by 2020-21.

But, since spending is projected to grow at an underlying real rate of 3.5 per cent a year, this would require an unprecedented restraint. And, even so, it would still require tax collections to grow 1.5 percentage points faster than the economy - equivalent to an ultimate $26 billion a year in today's dollars - over the decade.

Alternatively, were spending allowed to grow at its underlying rate, this could still leave us with a growing surplus, provided unrestrained bracket creep was allowed to cause tax collections to grow 3.3 percentage points (an ultimate $56 billion a year) faster than the economy.

And, get this. Were you to let spending grow at its "natural" rate, but limit growth in tax collections to a ceiling of 23.7 per cent of GDP - the level in the Howard government’s last year - the rest of the coming decade beyond 2018-19 would see an ever-rising budget deficit.

Whoever wins this election, I'll be amazed if taxes do anything but keep rising.
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Saturday, August 31, 2013

Forest logging propped up by conservationists

Everyone knows the environment and the economy are in conflict; that any effort we make to protect the environment comes at the expense of profit and jobs.

So, for instance, everyone knows that if the community wants to see restrictions on the logging of native forests in Tasmania, it's only reasonable for the government to compensate the industry and its workers for their loss of livelihood.

And this is precisely what the federal government has been doing for years. As long ago as 1989, the Tasmanian forestry sector received $42 million under the Helsham agreement. Under the Tasmanian regional forestry agreement of 1997, it got $110 million and under the Tasmanian community forest agreement of 2005, it got $203 million.

Under the Tasmanian forestry agreement - negotiated by the industry, unions and conservation groups, and finalised earlier this year - it will get another $300 million. Two weeks ago, as the battle for Tasmanian votes hotted up, Labor announced that the release of some of this money would no longer be conditional on the preservation of certain forests.

The national native forest industry has been doing it tough in recent years. Over the period from 2009 to 2011, removals of "roundwood" (logs) were 30 per cent below the average of the previous 18 years. And woodchip exports fell by a third between 2008 and last year.

The fall in production and exports has bankrupted the native hardwood industry's largest producer, Gunns Limited, and led to the closure of numerous processing facilities around the country.

State forest authorities have also recorded substantial losses. Forestry Tasmania recorded a net loss before tax and other items of $64 million over the four years to last year, an average of $16 million a year. The Forests Corporation of NSW recorded a total loss of $85 million over the same period, an average of $21 million a year.

The way the industry likes to tell it, it was hit by the banning of logging in certain forest areas and the tightening up of forest management practices. But while it was recovering from this blow, it was hit first by the global financial crisis and then by the high dollar (which has reduced earnings from exports and reduced the price of the imported forest products it competes against).

Talk about bad luck. Clearly, the industry just needs a bit of government help to keep it on track until things get back to normal.

And, indeed, all of the parties to the latest Tasmanian forestry agreement believe it will deliver "an ongoing, vibrant forestry industry in Tasmania based on native forests and, increasingly in the future, plantation".

There's just one problem: this is wishful thinking. The industry's story uses the environment as a convenient whipping-boy to draw attention away from its long-term structural decline - and probably demise.

The chequered story of the native forest industry and the way it has sucked ever-growing subsidies from governments can be deduced (as I have done) from a report prepared earlier this year by Andrew Macintosh, of the Australian National University, for the Australia Institute, The Australian Native Forest Sector: Causes of the decline and prospects for the future.

It's true the industry has been adversely affected by conservation measures, the global financial crisis and the high dollar. But they're secondary to its underlying problem of declining demand for its products and increasing competition both from other products and other, overseas producers of its products.

When you look at it, you see that the logging of hardwood native forests is under pressure from every direction.

To the extent that people still want hardwood, they increasingly prefer it from plantations, not native forests. But demand for hardwood itself is declining in favour of softwood, most of which comes from plantations.

Demand for wood is being reduced by demand for other products such as steel, by engineered wood (where thin bits of wood are glued together in different ways) and by wood-saving innovations.

And all that's before you get to increased competition from wood producers in other countries - competing in our domestic market and competing in our export markets.

The supply and future supply of plantation wood has been greatly expanded by another government subsidy, managed investment schemes, in which misguided punters overinvested in crazy pursuit of tax breaks.

Where the native forest sector can't sell its logs for use in building construction - as increasingly it can't - it sells them to be chopped into woodchips for papermaking. Naturally, woodchips are worth less. But even the native forest woodchip market is facing reduced demand and increased competition.

Macintosh concludes that "with sluggish demand in many key markets, strong competition from Asian, South American and African producers, and a distinct market preference for plantation-sourced products" and "in the absence of additional government assistance, the sector is likely to continue to decline and, in some areas, it could collapse entirely".

See what's happening? Our perception that protecting the environment is always in conflict with the economy and jobs is being used by the industry, its unions and the politicians as a cover for continued handouts to the industry, handouts that will do nothing but delay the inevitable.

And the conservation groups, having been convinced the industry's problems are all their fault, are running cover for an industry that doesn't want to face the truth and politicians trying to buy Tasmanian votes.

The result is that taxpayers are paying to allow an industry that probably would have collapsed to continue doing damage to native forests. It's getting help other industries wouldn't get, partly because it's doing something most other industries don't do: destroying the environment.

This makes sense?

If the conservationists had more sense they'd joint the economic rationalists in urging governments to stop giving subsidies - explicit and hidden - to an industry trying to defy market realities.

Environmentalists would do more good if more of them knew a bit of economics.
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Wednesday, August 28, 2013

Parties' sameness hides a big difference

You could be forgiven for concluding there's little to pick from in this election; the age of ideology is long gone and the true difference between the parties is minor. The two sides have assiduously eliminated their differences to the point where we're asked to choose between the red management team and the blue management team.

You could be forgiven for thinking all this because there's much truth to it. The more "scientific" and calculated politics has become the further the sides have moved towards the centre.

But it's not the whole truth. The parties may not be terribly ideological and - with the notable exceptions of Julia Gillard and Wayne Swan - they may assiduously avoid the language of class conflict, but they do play favourites in the policies they espouse.

If you think the class war is over, you're not paying enough attention. The reason the well-off come down so hard on those who use class rhetoric is that they don't want anyone drawing attention to how the war's going.

All of them except Warren Buffett, the mega-rich American investor. "There's class warfare, all right," he once said, "but it's my class, the rich class, that's making war, and we're winning."

The reason the wiser heads in Labor don't want to talk about class conflict, either, is they know it gets them nowhere. It alienates people at the top without attracting many at the bottom.

This, of course, is why the well-off like me are winning. The workers are too busy watching telly to notice the ways they're being got at. It requires attention to boring things like superannuation when you could be up the club playing the pokies.

The significant thing about the looming change of government is not that the economy will be much better managed - it won't be; these days most of the key decisions are made by the econocrats - but that the Coalition will bring to its decisions about taxing and spending a different bias to Labor's.

How can I say that? By looking at Tony Abbott's promises. If you do pay attention it's as plain as a hundred dollar bill.

Let's start with that boring question of the concessional tax treatment of superannuation. It's by far the most expensive example of (upper) middle-class welfare.

Super has always been a scheme heavily favouring those on the highest rates of income tax, who also happen to be those most able to afford to save.

But towards the end of his time as treasurer, Peter Costello introduced "reforms" that made it far more favourable to the well-off by making super payouts tax free and opening the scheme wide to "salary sacrifice" by those able to afford it.

At the time, many economists said what they're saying now about Abbott's paid parental leave scheme, that it was so generous as to be fiscally unsustainable.

And so it has proved. In its unending search for budget savings the Labor government has chipped away at that generosity in almost every budget (as I know to my cost).

And as part of its mining tax package, Labor finally acted to remove one of the most iniquitous features of the scheme.

It introduced the "low-income super contribution rebate" to end a situation where everyone earning less than $37,000 a year gained nothing from the concessional treatment of super contributions (while people like me saved tax of 31.5? in the dollar).

Earlier this year, when Labor was making noises about doing more to make super less inequitable - and the big banks and insurance companies were putting up their usual furious fight - Abbott promised to avoid any further changes for three years. Labor later topped this by promising no further changes for five years. Who benefits most from this moratorium - aspirational families in the western suburbs?

And get this: to help pay for its promise to abolish the mining tax - paid on their super-profits by three of the biggest mining companies in the world - an Abbott government would abolish the low-income super contribution rebate.

Who would benefit most from Abbott's opposition to Labor's plan to remove the concessional tax treatment of company cars?

Abbott's paid parental leave scheme would introduce a major new example of middle-class welfare. Since even most on his own side disapprove of it, it's guaranteed to be chopped back in future.

Then there's his pledge to remove the means-testing from the private health insurance rebate.

To its unforgivable shame, Labor has repeatedly refused to increase the poverty-level rate of the dole. In March, however, it began paying dole recipients a twice-yearly supplement of up to $105. No doubt as part of its campaign against waste and extravagance, an Abbott government would abolish this supplement.

Early in its term, the Howard government rejigged its grants to schools so as to favour private schools. After doing nothing for six years, the Labor government accepted the Gonski report's plan to bias school funding in favour of disadvantaged students, most of whom are in public schools.

After roundly condemning the Gonski proposals, Abbott affected a deathbed conversion to them as the election loomed. Read his fine print, however, and the parents of children at private schools can rest easy. The disadvantaged will soon be back at the back of the queue where they belong.
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Monday, August 26, 2013

Checkmate election spells fiscal indiscipline

It's truly ironic that after spending five years banging on about debt and deficit, and then proclaiming us to be in a budget emergency, the side most likely to form the next government has made one fiscally irresponsible commitment after another.

It's all part of the way the two sides' long-running battle of the scare campaigns has morphed into a checkmate election campaign in which most effort has gone into eliminating the differences between the parties, leaving them with little to debate and voters with little choice other than which side to "trust". What if you don't trust either lot?

It's just bad luck for those of us who believe fiscal sustainability is something to be achieved, not just talked about when it's convenient. Perhaps the most irresponsible act arising from the checkmate game is Tony Abbott's commitment - without time limit - never to change the goods and services tax.

This puts paid to big business's dream of increasing the rate or broadening the base of the GST (or both) to finance a cut in the company tax rate. But lots of people have their eyes on the GST as a solution to their problems and I think the premiers have first go.

They were promised a growth tax, but the return of the prudent household (whose consumption spending grows no faster than its income) and the faster-growing exclusions from the GST's base (most notably, private spending on health and education) mean collections from the GST aren't keeping pace with the public's demand for increased spending on most areas of state responsibility, but particularly hospitals.

When Labor keeps accusing its opponents of planning to cut spending on health and education, the Coalition vigorously denies it. But any federal party that refuses to increase collections from the GST will inevitably be squeezing state spending on health and education. (Meaning a re-elected Labor government would too.)

Rivalling the irresponsibility of refusing to change the GST is the Coalition's promise to make no further changes to the concessional tax treatment of superannuation, which Labor matched with a promise to make no changes for five years.

Super is the most egregious example of middle-class welfare - the less help you need, the more you get. So the side that needs to pay for about $28 billion worth of promised tax breaks over four years before it finds ways to cover government spending growing at an underlying real rate of 3.5 per cent a year swears not to touch the biggest rort going.

And the other side, which still doesn't know how it would cover the ever-growing later-year costs of the disability scheme and the Gonski education funding - on top of the inescapable strong real growth in healthcare costs - makes the same undertaking.

One thing you can be certain of is that the Coalition's pledge to avoid further reform of super means its two-year postponement of the phase-up of compulsory employer contributions to 12 per cent of salary will end up being permanent. No bad thing.

Next, note that in one of the few cases where one side outbid the other rather than merely matching it - the Coalition's far more generous paid parental leave scheme - the conservatives have opened up a brand new source of middle-class welfare, a lucrative new entitlement program, one that as well as being expensive and unfair will do little to increase labour force participation.

It's true, however, that there are two big examples of checkmate politics where the Coalition hasn't been as fiscally irresponsible as it would like voters to believe. The first is its me-too on Labor's disability scheme.

As Saul Eslake, of Bank of America Merrill Lynch, has pointed out, the little-remarked 0.5 percentage-point increase in all rates of income tax the Coalition has accepted as part of the package will start four years before the full scheme starts. I'm sure the extra revenue will come in handy.

The second checkmate that won't be as costly as it seems is Abbott's supposed about-face in accepting the Gonski education funding reforms. The first trick is that he's agreed only to match the first four years of spending. Most of the increase is in the following two years. And when he says he'd remove the strings Labor has attached to its scheme he means he will neither make the states contribute towards the cost of Gonski's reforms nor check to ensure they don't use the fed's new Gonski money to cut back their existing spending.

So Abbott's deathbed conversion to more equitable sharing of federal grants to public and private schools turns out to be no conversion at all, just an old private school boy's three-card trick.
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Saturday, August 24, 2013

Resurces boom now a growth negative but still going

Kevin Rudd keeps saying the China resources boom has ended, but Reserve Bank governor Glenn Stevens said recently the boom was merely "changing gear" and going through a "phase shift". So who should we believe?

The econocrat, of course. The politician is exaggerating. It's true, however, that we have reached a highly significant point in the boom: though it's far from ending, we've reached the point where it's gone from making a positive contribution to economic growth (real gross domestic product) to making a net negative contribution.

The resources boom we're living through is one of the most significant things ever to happen in the history of our economy. So it's worth getting a clear picture of it in your mind. It's not a simple story.

The boom began in 2003 and was divided into two parts by the global financial crisis of 2008-09. For a few months it looked as though it was over, but then it started up again to be bigger and better than before.

But here's the tricky bit: you can divide the life of the boom into three phases - hence Stevens' talk of a "phase shift".

The first phase was an almost unbelievable increase in the prices we received for our exports of coal and iron ore, prompted particularly by the rapid industrialisation and urbanisation of China and other developing countries. This greatly increased our export income and lifted our terms of trade - export prices received relative to import prices paid - to their most advantageous in about 150 years.

But minerals prices stopped rising and started falling a long time ago - the middle of 2011 - and since then our terms of trade have deteriorated by about 18 per cent.

It's clear prices have further to fall, but how far and how fast they fall we can only guess. Right now, our terms of trade are still very much better than they were in the decades before the boom.

And the econocrats are confident that, even when prices have fallen as far they're going to, our terms of trade will remain a lot better than they were. If so, this will be a lasting consequence - and benefit - of the boom.

The second phase of the boom followed from the higher prices: resource producers responded to the increased demand by greatly increasing their investment in new mines and facilities. That was particularly true for iron ore and natural gas, and to a lesser extent coal.

Stevens says annual new investment spending by the resources sector rose from an average of about 2 per cent of GDP, where it had spent most of the previous 50 years, to peak at about 8 per cent.

That's a phenomenal increase. And all that mining construction activity has been the main factor driving the growth in the economy for the past few years while the manufacturers and tourist operators have been hit by the high dollar, and home building and retailing have been hit by the end of the long credit boom and other problems.

But the construction phase seems now to have gone over the hill. Treasury observed in the economic statement that "with investment in iron ore and coal projects likely to have already peaked, future resources investment will be underpinned by liquefied natural gas projects already under construction".

So the big development is that the amount of mining investment spending seems to have stopped getting bigger from quarter to quarter - and thus contributing to the quarterly growth in real GDP - and will now get smaller each quarter, meaning it will now subtract from quarterly growth.

Note, however, that though the amount of construction activity will get smaller each quarter, more investment will still be happening each quarter. That is, the second, construction phase of the boom isn't over, it's just passed its peak.

Come back in five years time and we'll have a lot more mines and natural gas facilities than we have today. Don't let the economists' obsession with quarter-to-quarter growth mislead you.

The next thing to remember is that maybe 40 per cent of our total mining investment spending goes on the purchase of imported capital equipment.

And, obviously, money we spend on imports is a minus in the sum that gives us GDP, the value of domestic (local) production of goods and services. So a reduction in a minus helps with growth. Allow for the decline in imports and the reduction in mining investment spending doesn't subtract as much from the bottom line as first appears.

Which brings us to the boom's third phase, production and export, which is just getting going. As all the newly built mines and gas facilities come on line, we experience very strong growth in the volume (quantity) of mining production and exports of minerals and energy.

This, of course, makes a positive contribution to the growth of GDP - and it's the main reason for saying the boom is far from over. Stevens says volumes of iron ore are rising by about 15 per cent a year. Shipments of natural gas won't start increasing strongly until 2015, and will probably have several years of very strong growth then remain high for a few decades.

Treasury says the record surge in investment has more than doubled the resource capital stock (production capacity) over the past decade, and this will support strong growth in mining commodity exports for years to come.

Even so, when you put all the bits together - a negative contribution from slow mining investment spending, a positive contribution from fewer capital imports and a positive contribution from increased production of exports - you're still left with a net negative contribution to growth from here on.

Finally, don't forget this: we started with a mining sector that accounted for about 4 per cent of total national production. Now it's 10 per cent and counting - a lasting consequence of the boom.
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Wednesday, August 21, 2013

Why election campaigns have become so vacuous

For many of us, the big question isn't who should win the election - or who will - but why election campaigns have become so vacuous. Why so much politics but so little policy? So much argument but so little debate? So much sound and fury signifying not very much?

No doubt there are many reasons but I suspect an important one is that campaigning has become more professional, more scientific. The consultants and others who advise politicians have caused them to think more deeply about what they do and why they do it, what works and what doesn't.

The result is a more pragmatic, even ruthless attitude. It's not their job to foster debate, or ensure voters are fully informed on the choices available to them. And being open and accountable is more likely to lose you votes than win them.

If it's just about attracting enough votes to win, and that's not easy, better not to waste time on anything that doesn't do much to help. Why waste your energy trying to win the votes of people who long ago decided not to vote for you or those who are always going to vote for you?

So these days campaigns are directed at people who haven't made up their minds. It would be nice if these were people who were so deep into the policy choices they needed some extra convincing.

Sadly, politics doesn't work that way. The people whose votes are up for grabs tend to be those who don't have strong opinions, aren't ideological and don't take much interest in politics until the election is upon them.

I'm breaking it to you gently that modern election campaigns aren't aimed at anyone smart enough to read a paper like this one. They're for the people who don't think, not the people who do. So campaigns have become less cerebral and more emotional.

Politicians care more about the ads they run on telly than their televised debates. They find simple slogans and pithy sound bites more effective than complex arguments. They find scare campaigns - on the carbon tax, WorkChoices, the mining tax, debt and deficit, and the goods and services tax - very effective with people who are guided more by feelings than thought.

The way politicians look and sound has become as important as what they say. Perceptions matter more than reality.

Few of us have face-to-face contact with politicians during campaigns, so almost all we know comes to us via the media. So campaigns are a product of the symbiotic relationship between politicians and the media.

But the news media have long been in competition with the ever-growing range of other ways for people to entertain themselves in their spare time. So the news media have had to step up the entertainment content of their news, treating politics as a form of football - who's winning in the polls, who won the week, who's got a problem with their hammies - bringing us endless colour and movement on the campaign trail and eternally searching for laughable "gaffes".

The more the media try to keep news entertaining, the more they keep searching for novelty and changing the subject. They see themselves as catering to their audience's ever-shortening attention span, little realising that by changing the subject so often they're helping to shorten that span even further.

The opposition could have released all its policies weeks ago but it didn't because it needed to "maintain momentum" by releasing individual policies every few days during the five-week campaign. Because of this, we're told, it's unable to tell us how its promises will be paid for until the last week.

But this preoccupation with changing the subject combines badly with each side's strategy of focusing attention on a few issues it knows from its focus groups are its strengths, while shifting attention away from those issues it knows are points of vulnerability.

The amazing result is the large number of important policy changes in this campaign that have been announced but never referred to again as the campaign rushes on to something new. Sometimes both sides are in tacit agreement to slip through a tax increase without it being noticed. More often, one side checkmates the other on an issue, so there's nothing left to talk about.

Thus are we robbed of real choice by two sides who've done nothing but argue furiously throughout the three years of minority government.

Under the heading of looming tax increases it suits neither side to talk about (and so go unexamined by the media) the 0.5 percentage point increase in the Medicare levy, an effective doubling of the tax on cigarettes and a new tax on bank deposits likely to be borne by people with home loans.

Under the checkmate heading are the bipartisan promises to not make further changes to superannuation tax concessions (the biggest middle-class welfare rort of them all), to implement the Gonski school funding reforms (provided you don't read Tony Abbott's fine print), to implement the national disability insurance scheme (and worry about the full cost later), to leave the GST unchanged (and thus keep state spending on health and education under an unrelenting squeeze) and to waste yet more taxpayers' money chasing the pipedream of Northern Development.
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Monday, August 19, 2013

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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Saturday, August 17, 2013

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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Wednesday, August 14, 2013

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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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.
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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.
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