Monday, October 14, 2013

Miners pinch company tax-cut kitty

Let me make a fearless prediction: big business will get no cut in the rate of company tax in Tony Abbott's first term, and probably not in a second term, either. What you see before you now is all you're likely to get.

I doubt whether Abbott will break his promise to cut the company tax rate by 1.5 percentage points to 28.5 per cent from July 2015. But, of course, big businesses will get nothing from that. They'll be paying the new 1.5 per cent levy on big company profits to help finance Abbott's more generous paid parental leave scheme.

On Joe Hockey's own figuring, the levy will claw back 90 per cent of the cost of the company tax cut, leaving most listed companies no better off. The losers will be the Australian shareholders of those companies, who'll have 1.5? in the dollar shaved off their dividend franking credits.

The point to take away from these ins and outs is that, though the cut in the company tax rate yields no net benefit to big businesses, it still represents a $4 billion-a-year hit to the budget because Abbott effectively excused big business from bearing any net cost to cover the additional budgetary cost of souping up parental leave.

So Abbott's already done his dash on cutting the company tax rate. He's already made a cut he can't afford and it looks like being a mighty long time before budget finances return to being healthy enough - and the surplus fat enough - for him to afford another rate cut.

This is why more realistic proponents of a lower company rate accept that some explicit source has to be found to cover the cost of the cut. So any rate cut would have to be part of some give-and-take package that left the budget no worse off in net terms.

This, in turn, is why any rate cut would be part of a tax reform package that emerged following yet another major review of the tax system (as if the Henry report became useless on September 7).
But there's no magic in this process. The potential sources of higher taxation to cover the cost of a company rate cut are obvious and limited.

Many business executives dream of the goods and services tax being increased to cover the cost, but Abbott's repeated election promise that "there will be no change to the GST, full stop, end of story" puts paid to that. In any case, the premiers have a much stronger claim on any increased collections from the GST.

The other potential source is base-broadening: using the reduction of sectional tax breaks to pay for a cut in the rate of the tax. Julia Gillard attempted to get agreement to such a deal from the business lobbies in 2011, but no industry wanted a rate cut badly enough to be prepared to give up concessions.

Only to be expected? Such is the growing rapaciousness of the industry lobbies that you're probably right. But get this: all previous rate cuts (and we've come down from a rate of 49 per cent in the late 1980s) have been funded by government-imposed broadening of the company tax base.

Above all, remember this: Labor did come up with a package that would have financed a 2 percentage-point rate cut, but dopey big business let it slip through their fingers.

What was paying for the rate cut? The original resource super profits tax, of course. But business sat around with its eyes, ears and mouth closed while the largely foreign-owned big mining companies conspired to escape paying any specific tax on their huge resource rents.

Abbott is about to play out the last act in that monumental exercise in legal tax evasion by abolishing the mining tax before the exhaustion of accelerated depreciation allowances turns it into a much better earner.

Equally remarkable was the rest of business' inability to see it was they who were being ripped off by the miners, not some hated Labor government. It never crossed their tiny minds that the budget isn't a bottomless pit or a magic pudding; that if the miners get in first, there's not much left for everyone else. It's called opportunity cost.

It's time business woke up to the crude facts of fiscal life: the two most hugely profitable parts of our corporate sector are banking and mining. The more their economic rents are adequately taxed, the easier it is to afford to cut the company tax rate for everyone.

Abbott's abolition of the mining tax is the last nail in the coffin of the case for a lower company tax rate.
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Saturday, October 12, 2013

Governments should be pro-market, not pro-business

A fundamental question facing the Abbott government is whether it will succumb to the General Motors syndrome: what's good for big business is good for Australia. Does its slogan that Australia's now "open for business" actually mean open slather for business?

Will it run the country to please its business backers or to benefit all of us? Because the notion that what big business wants of government always coincides with what's best for the rest of us is a fairytale only a chief executive could believe.

Another way to put it - to clarify the choice Tony Abbott faces - is whether the government will be pro-business or pro-market.

The economic side of our lives is about producing and consuming; you can't have one without the other. To be pro-business is to favour producers, making life easier for them when they ask for help, whereas to be pro-market is to favour consumers, the people market economies are meant to serve.

As Adam Smith put it: "Consumption is the sole end and purpose of all production and the welfare of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer."
It's easy to tell yourself that by helping an industry you're helping its customers, though it's more usual to tell yourself you're saving workers' jobs. Business people lobbying to protect their profits almost invariably hide behind their workers' jobs, often making greatly exaggerated claims (claims they're rarely asked to substantiate) about how many jobs will be lost if their demands aren't met.

When you think it through, however, you realise that giving business people the easier life they seek isn't the way to maximise the benefit going to consumers, nor to maximise total employment. You may imagine - as does everyone on the left - that capitalist economies are designed to benefit the owners of capital above all others. In fact, in an efficiently functioning market economy the suppliers of capital get little more than a reasonable return on their investment, with most of the benefit going to consumers in the form of an ever-expanding range of reasonably priced goods and services.

The magic ingredient that brings this about - shifting the benefit from producers to consumers - is competition: competition between the producers but, just as important (and often lacking in our busy lives), competition between consumers and producers as consumers seek out the best deals and the best service.
When industries lobby governments for favours, what they're usually seeking is a reduction in the competition they're facing or about to face - all in the name of protecting their workers' jobs, naturally. They're seeking an easier life than the rough and tough life the capitalist system would otherwise serve up to them.

Often they're seeking protection from competition with imports. In the old days protection was achieved by imposing a tariff (import duty) on imported goods; these days a similar effect is achieved by granting the industry a subsidy from the taxpayer. Either way, the protection comes at the expense of the public.

But does it save jobs? It may save them in the particular industry being protected, but only at the expense of employment in the rest of the economy. How so? Consumers are left with less money to spend on the products of other industries. People in the protected industry don't care about that, of course, but the rest of us should.

Longer-term, protection involves keeping your head in the sand and pretending the rest of the world isn't changing. This is unsustainable. When the world we live in changes, we have to adapt to that change or become an industrial museum.

The way to maximise employment for everyone who wants to work is for us to pay the world price for everything and produce those goods and services where we have an advantage, and leave it to others to produce stuff where we don't have an advantage.

So being pro-market means examining requests for help from particular industries from the perspective of the economy as a whole. This avoids another problem: often one industry's request involves being favoured against rival industries.

Give in to one and the others redouble their screams of pain. You can't help 'em all, and if you try to you end up with a mollycoddled, inefficient economy.

Complicating things for the Abbott government is that its Labor predecessor didn't know how to say no to the business lobbies. And the more it said yes to particular industries the more dissatisfied, demanding and contemptuous the rest of business became.

Lobbying has become a way of life for big business, and no doubt the whole of business is expecting a bonanza now their own side is back in power.

If Abbott has any sense, he'll get the business lobbies back in their box from the start, telling them the era of rent-seeking is over. He'll stand up to big business the way Labor never could because, unlike it, he need have no fear of losing business's support.

The first place to stand up is against the unending blackmail game General Motors and the other global car makers are playing so successfully against all national governments.

And when he and Joe Hockey start delving into the budget, they'll find quite a few areas of hidden protection, starting with the plan to continue paying a fortune for faulty submarines to be made in Adelaide when much cheaper, better-working subs could be bought off the shelf in the US or Sweden.

Then there's the protection for local pill-making companies (not to mention retail chemists) hidden in the pharmaceutical benefits scheme.

And coming up is a bid by manufacturers to be exempted from paying the world price for gas when the eastern states become part of the world gas market in the next year or two. We'll hear a lot more about this one.
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Wednesday, October 9, 2013

Gas lobby working a scam on NSW citizens

The gas industry is working a scam on the people of NSW, in collusion with other business lobby groups and federal and state politicians. It's trying to frighten us into agreeing to remove restrictions on the exploitation of coal seam gas deposits. Failing that, the various parties want to be able to lay the blame for an inevitable jump in the price of natural gas on the greenies and farmers.
According to the gas lobby, the manufacturing lobby, the Business Council, federal Industry Minister Ian Macfarlane and former Labor minerals and energy minister Martin Ferguson, we have a looming gas supply crisis in NSW and must unlock our local coal seam gas resources if we're to avoid shortages and the price hikes they bring.
NSW Minister for Resources and Energy Chris Hartcher, at whom most of lobbying is aimed - his government boasts of "the toughest coal seam gas controls in Australia" - must fully understand the deception, but seems reluctant to expose the dishonesty of his Coalition and business mates.
The problem, we're told, is NSW produces only about 2 per cent of the natural gas its households and industrial users consume. And when facilities for liquefying and exporting gas start operating within a year or two, producers in Queensland and Victoria will switch to exporting their gas to gain the higher foreign prices.
So NSW is facing a massive shortage of gas, which will cause a big jump in gas prices and threaten the jobs of thousands of people working in gas-dependent industries. The obvious answer, we're told, is for NSW to fill this supply gap and avert the price hike by urgently developing its own supply of coal seam gas.
There's just one problem with this neat story: it reveals - or exploits - an ignorance of how markets work. The lobbyists' faulty logic is ably exposed by the Australia Institute's Matt Grudnoff in his paper, Cooking up a price rise.
For many years, the prices paid for natural gas by consumers on Australia's eastern seaboard have been a lot lower than prices paid in other countries. The absence of plants to liquefy the gas so it could be exported meant our market was cut off from the world market.
We had no liquefaction plants because we didn't have enough gas to make them profitable. What's changed is the advent of fracking, which has enabled us to begin exploiting our extensive deposits of coal seam gas.
The development of "unconventional" gas in Queensland has progressed to the point where it's become economic for three liquefaction plants to be set up near Gladstone. When those plants start operating in a year or two, the barrier that separated our eastern seaboard gas market from the world market will disappear and the era of low gas prices will end.
Grudnoff estimates the wholesale price of gas will double or treble from between $3 and $4 a gigajoule to the world "netback" price of $9 a gigajoule. "This is because Australian gas producers will have the option to sell to the Japanese, who are willing to pay $15 a gigajoule," he says.
The difference between $15 and the netback price - also known as the export parity price - is the cost of liquefying the gas and transporting it overseas. If you're as ancient as I am, this should remind you we've already been through a similar process of the low local price rising to the high world price when the Fraser government introduced export-parity pricing for oil in the late 1970s.
The percentage rise in retail gas prices paid by households will be a lot smaller than the rise in the wholesale price. Estimates by Hugh Saddler, of the energy consultants Pitt & Sherry, suggest Sydney retail prices will rise by 11 per cent to 18 per cent - roughly twice the rise caused by the introduction of the carbon tax.
The point is, wholesale and retail prices will rise to the new export parity price throughout the eastern seaboard. In Queensland where the frackers have had an easy ride, and in Victoria where the present moratorium on fracking seems likely to give way to an unrestricted regime, just as much as in NSW where the frackers are given a hard time.
Because of pipelines between the states, how much gas a state produces has nothing to do with the prices its households and businesses pay. According to the gas lobby's logic, the coming ability of producers to get much higher prices by exporting their gas should produce shortages of gas for local users in Queensland and Victoria, not just NSW.
In truth, there will be no shortages of gas in any state, just a requirement to pay the higher, netback price. There's no reason producers would prefer to sell to foreigners if locals are offering to pay the equivalent price.
With the advent of fracking and access to higher prices, it's not surprising gas producers are desperate to extract as much coal seam gas as possible as soon as possible. But their argument that increased production in NSW could hold down NSW gas prices is economic nonsense.
Any new gas producers in NSW won't be willing to sell to locals for anything less than the equivalent price they could get by selling to foreigners. That's the scam.
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Monday, October 7, 2013

Our ever-rarer elixir: restraint

There's a paradox at the heart of modern capitalist economies: if they really worked the way economists think they work, they wouldn't work for long, they'd seize up. And as the Yanks have been busy demonstrating, it's a similar story for modern democracies.

Economists believe the motivating force driving market economies is self-interest: businesses and consumers do what they do purely for their own benefit. But the "invisible hand" of market forces transforms all this selfishness into a system by which everyone benefits.

Although most economists prefer the euphemism "self-interest", Professor Paul Frijters, of Queensland University, prefers to call it "greed" in his path-breaking book written with Dr Gigi Foster, of the University of NSW, An Economic Theory of Greed, Love, Groups and Networks.

Frijters argues that a variety of "institutions" is required to ensure individuals' greed doesn't prevent the operation of free markets. If people will do anything to increase their material wealth, as implied by the Homo Economicus view of humanity, why would they simply pay the prices traders wanted to charge? Frijters asks.

"Why would they not, for example, steal products or production technology, kill competitors, or in some other way seek a market advantage through dishonest or immoral behaviour?" he asks.

Because of the existence of formal and informal institutions. Formal institutions include parliaments that pass laws prohibiting certain behaviour and police and courts that enforce those laws.

But ask yourself this: is your knowledge that it's illegal and that you risk being punished the only reason you don't steal from shops, your employer or your neighbours? Do you adhere to contracts only to avoid having to defend your behaviour in a court case with the other side?

Of course not. Even where we're confident of not getting caught, almost all of us refrain from doing those things because we don't believe they're the right thing to do. And there is any number of perfectly legal things we could do, but choose not to. So our behaviour in the marketplace - or in politics - is also constrained by a host of informal institutions, such as notions of fairness, conventions, customs, rules we've internalised and other norms of socially acceptable behaviour.

"Formal and informal institutions in combination are important in the running of societies, as together they form the rules of the game to which people adhere. They constrain the possibilities for opportunistic behaviour in human interactions," Frijters says.

This isn't the first time the US Congress has refused to pass the budget and thus shut down the US government, but it's rare. The Financial Times' Martin Wolf, doyen of the world's economics editors, observes that if President Obama's political opponents are prepared to inflict such damage on their own country, "the restraint that makes democracy work has gone".

Dr Chris Caton, of BT Financial Group adds: "Thank god that couldn't ever happen in Australia!" Not half.

Just as we need social norms to restrain our instinctive selfishness and so keep the economy functioning smoothly, we need restraint among the players in the political game to ensure we don't descend into impasse and policy impotence. But as the Americans' appalling predicament reminds us, restraint isn't a given, and can't be taken for granted. Our selfishness does propel the economy onward and upward, but when voluntary restraint breaks down - almost always egged on by competition - we can end up with greedy bankers causing the devastation of the global financial crisis.

Similarly, we need our adversarial two-party system of democracy to keep a check on the corruption and incompetence of governments, but when personal ambition and party rivalry become unrestrained, government suffers.

The sweeping economic reforms of the Hawke-Keating era were made possible by John Howard's principled restraint in providing bipartisan support. But bipartisanship in the interests of good government ended with Labor's opportunistic scare campaign against Howard's GST.

Tony Abbott returned the favour with his ruthlessly dishonest scare campaigns against the carbon tax and the mining tax. Now how do you think Labor will react should Abbott propose a controversial reform in this term or the next?

The self-seeking, short-sighted, rivalry-fanned lapse in restraint by both sides makes further major economic reform highly unlikely until, by some hard to imagine means, the former norms of acceptable political behaviour are restored.

But don't blame it all on the politicians. That's too easy. As Professor Ross Garnaut observed in May, the past dozen years have seen "interest groups" - I'd say industry lobby groups - become less inhibited in pursuing private interests at the expense of the wider public interest, ferociously resistant to reform proposals involving private costs to them, and willing to pursue their private interests by costly ad campaigns and party donations.

Less restraint, less reform.
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Saturday, October 5, 2013

Economist proposes a socio-economic model

What can economists tell us about love and power, why people are loyal, how groups form and how they get their members to abide by the group's norms of acceptable behaviour? Not much.
Everyone knows conventional economics is built on a stick-figure conception of humans and the way they work.
 
Until now. An economics professor at the University of Queensland, Paul Frijters, has attempted the remarkably ambitious project of developing a unified theory of human behaviour, turning the mainstream model of the economic system into a model of the socio-economic system.

With help from Dr Gigi Foster, of the University of NSW, he's set it all out in the book An Economic Theory of Greed, Love, Groups and Networks. We'll find out soon enough what the rest of the economics profession makes of it.

He starts with the principles of mainstream economics, then adds and integrates selected ideas his research has determined have considerable power in explaining human behaviour.

The bit he starts with, which comes straight from the mainstream, is the assumption that humans are carefully calculating maximisers of their personal benefit. Or, as Frijters prefers to put it, ''humans are mainly motivated by greed''.

This conception of ''homo economicus'' - economic man - emerged in the Enlightenment period. In the early Middle Ages, by contrast, materialism was seen in society as strongly immoral, Frijters explains.
Even so, it's a quite one-dimensional conception of human behaviour. We're a lot more complicated than that. This assumption accounts for much of the criticism of conventional economics (including from yours truly).

So the ''core concepts'' Frijters adds to the conventional assumption of ''greed'' aim to broaden the model's explanation of human motivations and behaviour.

The first concept he adds is ''love'', by which he means love for other humans, but also love for one's beliefs. ''Love is defined as a form of unconditional loyalty, and will be said to be present whenever a person would be willing to help advance the interests of the object of his love, even if the object of his love would not notice the help and even if the loving person would receive no observable reward,'' Frijters says. So love includes the ideas of altruism and loyalty.

''Selfish materialism is extremely powerful in explaining many of our laws, our customs, our politics, and our choices as consumers. Yet selfish materialism alone cannot lead to the kind of human organisations we see in reality.

''I expect to see love as a major player involved in almost every facet of an individual's decision making ? Love within companies should be an integral part of how teams of people actually get things done within organisations.''

Another major criticism of the simple model of conventional economics is its assumption that each of us acts only as an individual, unaffected by the behaviour of those around us. This means no ''economic actor'' has more power than another.

In truth, humans are a group animal whose self-image is inextricably linked to the groups of which they are part. And the reality is that the dominant power relations in modern societies aren't between one individual and another, but rather between individuals and groups.

So the second feature Frijters adds to the mainstream view is groups and the power they generate. Each of us is a member of any number of groups, affecting our family life, social life and working life. Beyond that, our religion, ethnicity and nationality make us members of more, often powerful, groups.

It's because groups generate and exercise power that they need to be added to the model. Power is the ability to influence the behaviour of others. Part of this power comes from the development of norms of acceptable behaviour within the group. Many of us feel considerable loyalty to the groups we're in, which partly explains why we confirm to group norms.

Frijters argues there are five basic types of social groups: small hierarchies, with a clear leader, a few of high rank and a group of underlings totalling no more than a few dozen individuals in all; small circles of reciprocity, with people who are equals and share a common goal; large hierarchies, where members don't know each other; large circles of reciprocity; and networks.

Networks are his third addition to the mainstream view. They are facilitators of exchange - of goods and services, or just information. They exists because of the need to overcome ''frictions'' in markets arising from the information and transactions costs the simple mainstream model assumes away.
Individuals search for goods, buyers and suppliers within networks of small size or large anonymous networks such as the internet.

So how does Frijters' model improve on the answers to questions from the mainstream model? What questions does it answer that the mainstream can't?

On the common questions of whether international trade should be encouraged or protected against, what governments should do about monopolies and how to discourage firms from polluting, his model doesn't much change the conventional answers.

But it can answer some questions the conventional approach can't. With its assumption of calculating, self-interested behaviour, the old approach can't explain why people go to the bother of voting when the chance one vote will change the outcome is minuscule.

Frijter's model says people vote because they're idealistic and identify with the group that is Australian voters.

Nor can the old approach explain why people don't avoid or evade paying tax a lot more than they do. Rates of ''voluntary compliance'' are, in fact, surprisingly high (though not as high as in the old days).
Frijter's model says people feel loyalty to the group of fellow Australians and conform to the social norm that paying taxes is a form of reciprocity that's reasonable to expect of members of the group.

And this is no idle question. He says getting people to pay taxes is probably the single most important ingredient supporting our system of governance.
Read more >>

Wednesday, October 2, 2013

Abbott should repeal great big 'Australia tax'

When government changes hands, it s possible for important issues to fall between the cracks and useful work to be lost. In late July, a Labor-constituted parliamentary committee issued a report about the Australia tax . It drew a fair bit of media attention at the time but, coming so close to the election campaign, was soon forgotten.

But the report made some important recommendations recommendations the Coalition members of the committee were happy to support on measures the government could take to reduce the Australia tax and it s important the new government takes up those recommendations.

The report was an inquiry into the prices of information technology hardware and software sold in Australia, conducted by the House of Representatives standing committee on infrastructure and communications. It found, unsurprisingly, that Australian consumers and businesses must often pay much more for their IT products than their counterparts in comparable economies. Hence the term Australia tax .

Evidence presented to this inquiry left little doubt about the extent and depth of concern about IT pricing in Australia. Consumers are clearly perplexed, frustrated and angered by the experience of paying higher prices for IT products, the report says.

Submissions to the inquiry compared the prices of more than 150 professional software products and found an average price difference usually between Australian and US prices of 50 per cent. The median price difference was 46 per cent for Autodesk products, 49 per cent for Adobe products and 67 per cent for Microsoft products. Submissions compared the prices of more than 50 IT hardware products and found a median price difference of 26 per cent. Comparisons of 70 music products found a median price difference of 67 per cent. For 70 games products it was 61 per cent and for 120 e-books it was 13 per cent.

How can such differences be justified? A lot of possibilities spring to mind. Taxes might be higher in Australia. For physical products, freight and handling costs would be higher. Australian companies may face higher rent and wage costs. And our much higher dollar has greatly improved the comparison between the prices of imports and local prices.

Obviously, the inquiry needed a lot of help from the representatives of the global IT companies to explain these puzzles and possibilities. It didn t get it. The big companies repeatedly declined to appear before the committee, sometimes saying they d be represented by their industry body while the body said it couldn t represent the views of individual members.

So in February the committee took the unusual step of summonsing Apple, Adobe and Microsoft. The evidence they gave was incomplete, conflicting and unconvincing.

It s hard to see how claims of higher costs in Australia can account for the price differences, particularly in the case of content that s delivered digitally. And when the same overseas site puts up its prices for such content as soon as it discovers you re from Australia, it s hard to avoid the conclusion there s something funny going on.

The inquiry concluded that many IT products are more expensive in Australia because of regional pricing strategies implemented by major vendors and copyright holders .

Just so. To anyone with any training in economics it s obvious what s going on: global IT companies are engaging in price discrimination by charging different prices for the same product in different parts of the market. They maximise their profits by charging what the market will bear in each market segment, taking advantage of differences in customers willingness to pay .

Economists have long studied this phenomenon and regard it as perfectly normal profit-maximising behaviour. Global companies charge higher prices in Australia than in the US because they know Australians have a higher willingness to pay than Americans have. Why? For no reason other than that we re used to paying higher prices than the Yanks are used to.

As the inquiry s report acknowledges, there s nothing new about international price discrimination. It s been going on for decades. What s new is the digital revolution. The internet has made it much easier for us to see what s going on and get around it.

Economists know that for price discrimination to succeed, you have to be able to keep the two markets separate. Otherwise people will switch to buying in cheaper markets or some middleman will make a quid by doing it for them.

To keep national markets separate in the old, physical world, many governments used legislative bans on parallel importing , where companies buy in the cheaper market and sell at a discount in the local market.

To keep national markets separate in the digital world, big companies use various forms of geoblocking the use of internet addresses, credit card numbers or other means of electronic identification to block internet sales and downloads of electronic products ... based on the geographic location of the consumer .

There are ways around geoblocking ask any teenager to show you but it s not certain all the ways around are strictly legal.

So the committee recommends the government remove the few remaining parallel importation restrictions in the Copyright Act and also secure consumers rights to circumvent measures supposedly intended to protect copyright, which are being used to impose higher prices on honest customers.

And it should amend the Competition and Consumer Act to render void consumer contracts that seek to enforce geoblocking.

Let s hope Tony Abbott is still listening.
Read more >>

Monday, September 30, 2013

Hockey can turn budget problem into big reform

Perhaps the biggest question the Abbott government needs to ask itself is whether it aspires to be a highly regarded government or merely one that's "better than the last lot". Paradoxically, to end up highly regarded you have to be bold, run risks, even do the opposite of what was expected.

Consider the case of the budget. On the face of it, Treasurer Joe Hockey's problem is that the closer he got to inheriting the budget and its deficit, the more he realised that - contrary to everything he and his boss had been saying for three years - returning it to surplus would be no easier for the Coalition than it had been for Labor.

That's why, in the campaign proper, he took care to make no meaningful promise about when he would get back to surplus - even leaving open the possibility it wouldn't be within the government's first term - and why, as soon as the election was won, all talk of a "budget emergency" instantly self-destructed.

Had a Labor government changed its tune so abruptly we would never hear the end of it. But Hockey is right in confidently assuming a Liberal treasurer can get away with things no Labor treasurer could. Tony Abbott keeps saying the Libs have good economic management in their DNA and, as decades of polling make crystal clear, most punters know in their heart it's true.

In other words, Hockey's budgetary performance need be no better than Labor's for his government to be judged "better than the last lot".

But the challenge he faces isn't quite that simple. As we were reminded last week by two economics professors from Melbourne University, John Freebairn and Max Corden, some time over the next year or two investment spending by the mining industry is expected to drop from 8per cent of gross domestic product to 2per cent.

That's a massive fall in economic activity. And it's not at all certain the most expansionary stance of monetary policy (low interest rates) will be sufficient to ensure consumption and investment spending in the rest of the economy are strong enough to offset that massive fall.

Saul Eslake, of Bank of America Merrill Lynch, says there's a 25 per cent chance the economy could contract in 2015. The econocrats think that sounds pretty right.

Even if the economy didn't actually go backwards, it could easily slow to a point where unemployment started climbing rapidly. With monetary policy already fully extended, what should a responsible treasurer do? Stick with all the anti-Keynesian rhetoric about unnecessary, even wasteful fiscal stimulus the Liberals subjected Labor to, and do precisely nothing?

The treasurer - Liberal or Labor - who could resist the temptation to use the budget to apply stimulus at a time when the economy was slumping has yet to be born (the ill-fated John Kerin excepted). Hockey would be no exception.

As the two professors have argued, the obvious answer to the rapid retreat of mining investment spending is to fill the vacuum by ramping up federal infrastructure spending. They propose being ready to roll out a "capital investment stabilisation fund".

This would limit the rise in unemployment, invest at a time when construction prices were low and, if the projects were well chosen, help raise the productivity of the wider economy.

Even so, it would involve consciously adding to the budget deficit at a time when all your debt-and-deficit-anxious supporters were expecting you to do the reverse. This could present credibility problems even for the most arrogant treasurer.

What to do? Follow the example of the state governments and redefine the deficit to include recurrent spending but exclude capital spending. This would bury the Libs' hypocrisy under genuine fiscal reform.

The one glaring conceptual weakness in the bipartisan medium-term fiscal strategy to "maintain budget balance, on average, over the course of the economic cycle" is its failure to distinguish between recurrent and capital spending.

Shifting the focus to the budget's "operating" balance (as opposed to its overall borrowing requirement) would retain the discipline of public opinion over recurrent spending, though it would risk taking the discipline off capital works spending, which is undoubtedly susceptible to political temptation.

This why the reform should be completed by taking up the professors' proposal that all capital projects be rigorously evaluated by a body with independence, similar to the Productivity Commission's, which would publish benefit-cost assessments for all major projects.

If Abbott and Hockey could summon the courage to make such a reform, they would immediately put themselves up with Bob Hawke and Paul Keating, John Howard and Peter Costello.
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Saturday, September 28, 2013

Why borrowing for investment isn't a problem

It doesn't seem to have occurred to anyone - perhaps not even the man himself - to wonder how Tony Abbott can establish himself as an ''infrastructure prime minister'' and also get the budget back to surplus ASAP.

It doesn't seem to have occurred to anyone - perhaps not even the man himself - to wonder how Tony Abbott can establish himself as an ''infrastructure prime minister'' and also get the budget back to surplus ASAP.

He's certainly right to imply we need to be renewing and expanding a lot of our infrastructure and that this can't be left solely to the state governments.

But as everyone knows, building new infrastructure can be very expensive. In principle, it can be paid for by increasing taxes, by cutting spending elsewhere or just by allowing the budget deficit to get bigger and borrowing to cover it.

Trouble is, from where Abbott sits, none of those possibilities looks attractive. He's spent four years railing against higher taxes, and though he's also promised to cut government spending by eliminating Labor's waste, in practice it's hard to get much agreement on what's wasteful and what's not. It's highly unlikely Abbott could identify sufficient waste to pay for much infrastructure as well as getting the deficit down.

But simply allowing the deficit to get bigger by borrowing to finance infrastructure spending is surely unthinkable. Leaving aside all Abbott and Joe Hockey have said about the Labor government's debt and deficit, wouldn't it involve living beyond our means and leaving our debts to be inherited by our children and grandchildren?

(There is a fourth possible solution, to use ''public-private partnership'' arrangements to get the private sector to pay for and build the infrastructure and then, in effect, rent it back to us. But even if you think the private sector is better at building and managing infrastructure than the government, this solution is still a way of hiding the debt by shifting it off the government's books onto those of the private sector. It involves creative accounting.)

So what about this notion of living beyond our means and burdening future generations? I'm sure this is a big part of the reason so many people agreed with the Liberals' attack on debt and deficit.

This is an issue to which economists have given much thought over many years (more thought, dare I say, that many of the people who readily accepted Abbott's argument).

For a start, economists and accountants have long drawn a distinction between day-to-day spending to maintain the operations of a household (or a business or a government) and spending of a capital nature, where you're building or buying some kind of asset that will last for many years, that will contribute to meeting your day-to-day needs for many years, and usually can be sold to someone else if circumstances change.

An accountant will tell you you're only living beyond your means if you're borrowing to cover day-to-day needs (''recurrent spending''), not if you're borrowing to buy an asset that will retain its value for many years. After all, do you regard a family that borrows to buy a home, thereby acquiring a mortgage usually many times greater than its annual income, as living beyond its means? Of course not.

But the analogy between households and governments shouldn't be pushed too far. A family and a government have very different sizes, obligations and powers. Governments, for instance, have the right to levy taxes, which is one reason their borrowings are regarded as low-risk.

And when it comes to borrowing by governments to finance infrastructure, economists have given the matter much thought. Two professors at the University of Melbourne, John Freebairn and Max Corden, argue in a paper this week that by focusing on the debt being left for the next generation we're seeing only half the story.

Their first point is that spending on needed infrastructure and other things of a capital nature benefits the economy we all live in. By increasing the economy's productivity, it leads to economic activity far greater than just that which is involved in building the infrastructure. This leaves the community better off, as well as generating increased tax revenue for state and, particularly, federal governments.

So were we to decide to build no more infrastructure than we could afford to pay for without borrowing, we'd also be deciding to keep the economy less productive than it could be and thus to leave for the next generation a less-productive economy than it could have.

That's the ''economic efficiency'' case for borrowing to fund infrastructure (and also such things as education and training, which add to the economy's stock of ''human'' capital). But next the profs outline the equity case, involving ''inter-generational equity'' - fairness between the generations.

Many people have become conscious that government debt may remain unrepaid and so become a cost imposed on our children. True. But in the case of spending on infrastructure and other forms of capital, which will deliver benefits to the community over periods of 30, 40 years or more, it's equally true that our children will enjoy the benefits.

As the profs put it, ''these same future generations reap most of the investment benefits of a more productive economy and higher income levels''. Sound unfair to you?

But, being economists, the profs are very much aware that some government infrastructure spending can be undertaken for short-term political gain, not long-term economic benefit. To guard against this, they outline two questions to be asked of every infrastructure proposal.

First, are there good reasons for government investment rather than leaving the decisions to the private sector and competitive market forces?

Second, have the chosen investment projects passed explicit, transparent and robust benefit-cost assessments? And then, if funds are limited (as they always are), have the higher yielding projects been selected?

They say a body with independence similar to the Productivity Commission's should be set up to evaluate projects and publish rigorous benefit-cost studies. Governments would be free to reject the body's advice, but would have to justify this to a better-informed public.
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Wednesday, September 25, 2013

Is reversing Labor all we need for our future?

I'm starting to think we didn't get much of a deal when we decided to change the federal government. We got rid of a bunch racked by infighting and bad at executing policy, but substituted a bunch with a very limited idea of what needed to be changed to get us back on the right path.

What a to-do list: sack econocrats guilty of having worked with the enemy, pass an edict against climate change and discourage all discussion of it, stop publicising boat arrivals, build more motorways, move to a cut-price national broadband network and take science for granted.

It's early days, of course, and there's more, but not a whole lot more: abolishing the onerous tax on our impoverished global mining companies, getting rid of red and green tape (translation: making it easier for big business to get its way without delay) and beating up the Tax Office for being too diligent in making small business pay its tax.

It's as if Tony Abbott believes returning the Liberals to power will, of itself, solve most of our problems. Everything was fine when we last had a Liberal government, so restore the Libs and everything will be fine again.

It smacks of complacency, of a belief that nothing much has changed or could change. But that's not how Ian McAuley, an economist at the University of Canberra, sees it in his chapter of a new book from the Centre for Policy Development, Pushing Our Luck: Ideas for Australian Progress.

McAuley argues that, after another round of good luck with the resources boom, we need to secure our long-term prosperity by building a more resilient economy. (He harbours the eccentric notion that there's more to economy policy than balancing the budget, but even Abbott has abandoned that goal.)

"The legacy of our economic history conditions how we think," McAuley says. "After Federation we diversified our economy by building up a strong manufacturing base behind tariff walls. That started out as a smart policy, but it has left us with an undue concern for 'making things' rather than creating value.

"Our success in commodities, which allows for little product differentiation, has contributed to a 'price taker' mentality in business and therefore an obsession with production costs. We think about productivity in terms of mere cost reduction, particularly when labour costs are involved ...

"And our strong growth in the 20th century has created unrealistic expectations about profitability; we find it hard to imagine that the days of easy investment returns may be behind us."

We need to break free of the notion that our economic fortune must inevitably be driven by the fluctuating demand for minerals and energy, McAuley argues. And our dependence on coal exports makes us particularly vulnerable.

"As more countries place a price on carbon, or switch to other energy sources for local environmental or health reasons, there is a chance that we could find ourselves left with some large holes in the ground and idle ports and railways."

The experience of many countries shows that an abundance of natural resources can become a curse because it leads them to keep all their eggs in one basket.

"The consensus among economists is that countries can avoid the resource curse only by treating natural resources as an opportunity to invest through a sovereign wealth fund or domestically in education and infrastructure.

"We should see carbon pricing as an opportunity for industry modernisation, to prepare for an era in which many countries are cleaning up their energy sectors and limiting their carbon emissions."

McAuley says the old manufacturing model was one in which physical capital was expensive and labour was comparatively cheap. Our thinking, still focused on physical capital, distracts us from a new realisation of the meaning and role of capital.

"Capital in the form of a row of machines or a fleet of trucks is less important than the capital in the form of ideas, skills and education, capacities to communicate and to work with others - human capital, in other words. It is the knowledge worker who is emerging as the capitalist of our day, but we are a long way from recognising this."

Rather than thinking about manufacturing and its products, we should think about activities people undertake in adding customer value. Some activities involve transformations to physical products, but there are many other ways to apply skills to add value.

"Policies directed at developing manufacturing for its own sake are bound to fail. Those that enable businesses to adapt to big changes and to develop strong positions in global value chains are more likely to be effective for all businesses, regardless of their sector."

In summary, McAuley says we need to understand the risks of being too dependent on natural resources, break from our old obsession with producing physical products, focus on increasing customer value and not just reducing costs, get rid of the class struggle model of economic activity, stop thinking the only goal is job creation and develop realistic ideas about the rate of profitability.

"We pay far too little attention to our human capital. We still see education expenditure as an expense, or even as a welfare entitlement. And we pay even less attention to our environmental, social and institutional capital," he concludes.

It's hard to imagine Abbott has any of these things in his field of vision.
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Monday, September 23, 2013

No need to exaggerate Labor's failings

They say history is written by the victors, and already the Rudd-Gillard-Rudd government's many critics are busy reshaping our memory of the recent past. But, though Labor's performance was poor in many respects, they shouldn't lay it on too thick.

Those who claim Labor Party governance led to "chaos" should look up the meaning of the word, while those who repeat Tony Abbott's claim that this was "the worst government ever" are too young to remember the Whitlam era.

What is true is that Labor's latest incarnation was far inferior to the 13-year Hawke-Keating government. In just the term of the Howard government, Labor seemed to lose its race memory of how to govern.

Rather than blame all its troubles on the three years of Rudd-Gillard infighting, or keep telling itself its policies were good, Labor needs to reflect deeply on why its execution of policy fell so far short of the Hawke-Keating example.

A fair bit of the reason is its failure to unceasingly explain and justify its policies and instead rely on wet-behind-the-ears spin doctors and dodgy taxpayer-funded ad campaigns.

Rather than explain and justify, ministers preferred to criticise their opponents, forgetting the punters are never edified or impressed by arguing pollies and inadvertently giving the opposition greater credibility. Labor forfeited most of the advantages of incumbency.

One big difference was the way Bob Hawke and Paul Keating maintained the confidence of business. Part of the explanation was that when you reveal yourself to be a soft touch for rent seekers - as Rudd did almost from the start - you incite envy and disaffection, not respect.

Another part of it was Gillard's resorting to the rhetoric of class conflict, which did much more to disenchant business than to energise complacent workers. Hawke and Keating did a lot to redistribute income, but didn't make speeches about it.

The more Abbott and Joe Hockey are forced by economic reality to back-pedal on their promises to "end the waste" and "repay the debt", the more they'll cover their retreat by exaggerating Labor's budgetary failings.

So let's set the record straight from the start. It's unimpressive enough without any need for hyperbole.

The standard critique of Labor governments is that they're "big-spending, big-taxing". This time the latter accusation is false, but the former is all too true.

If you measure the burden of federal taxes as a percentage of gross domestic product - as you should - it reached an all-time high of 24.2 per cent in the mid-noughties and was 23.7 per cent in Howard's last year.

Under Labor, and with much help from the recession we supposedly didn't have, it fell to 20 per cent in 2010-11 and is expected to have recovered only to 22.2 per cent in Labor's last year.

How could this be when Labor introduced two "big new taxes" on carbon and mining? The trick was that most of the expected revenue from these taxes was returned to taxpayers on the form of income tax cuts, business tax breaks and other "tax expenditures". This is why Abbott's unwinding of both tax packages will do so little to cut taxes overall.

Turn to the spending side, however, and you find spending was 23.1 per cent of GDP in Howard's last year and is expected to reach 25.3 per cent in Labor's last year. That represents average real growth of 3.9 per cent a year.

Both those calculations effectively abstract from Labor's clearly labelled fiscal stimulus spending after the global financial crisis, because it really was temporary.

And that average real growth rate of 3.9 per cent occurred even though, in the last four of its six budgets, Labor professed to be more than achieving its goal of limiting real spending growth to 2 per cent on average over the forward estimates.

How was this trick done? All the restraint was in the "out years", never the present. To be fair, real annual spending growth averaged 3.7 per cent in the 10 Howard years before the financial crisis.

The big areas of growth under Labor were public housing, education and health, not counting the biggest, interest on the public debt.

Treasury projected in its pre-election economic and fiscal outlook that, left to its own devices, spending will grow at the real rate of 3.5 per cent a year in the coming decade, spurred by health, the national disability scheme and the Gonski education reforms.

Labor's problem was that its appetite for increased spending on worthy causes knew no bounds but it lacked the courage to ask the electorate to pay more to cover this expansion.

We'll see how much more courageous Abbott and Hockey prove to be.
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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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