Saturday, November 30, 2013

Rise in living standard set to slow

It's a funny thing about the awful truth: people are much more inclined to talk about it after elections than before. And it seems as though, of late, our top economists have done little but tell us our economic future is a lot more "challenging" than was contemplated during the election campaign.

The first sobering message is that getting the budget back to balance won't be as easy as it suited both sides to pretend in the three-year campaign. Indeed, it could be a struggle that goes on for at least a decade - depending on how long it takes us to face up to some tough decisions.

The next soberer is that our material standard of living is likely to improve at a much slower rate in the coming decade than it did in the last one. We got that warning in a speech last week by Dr David Gruen, the top macro-economy manager in Treasury. And we got it again in a speech this week by Dr Philip Lowe, deputy governor of the Reserve Bank.

The simple way to see what's happening to our standard of living is just to take real gross national income and divide it by the population, to give real income per person.

According to Treasury's calculations, this grew at an average rate of about 2 per cent a year during the 1970s, '80s and '90s. Over the 13 years to this year, it grew by 2.3 per cent a year. But over the coming decade to 2023, Treasury's best guess is the rate of real improvement will slow to a bit less than 1 per cent a year.

That's more than a halving in our rate of material advance. What is it that's expected to cause this marked slowdown? Well, that's a long story. Settle back.

The greatest single factor causing our standard of living to rise almost continuously over the years is improvement in the productivity of labour - that is, increased output of goods and services per hour worked. Labour productivity improves when workers are given more machines to work with, when workers' skills improve because of education and training, when improvements in public infrastructure allow firms to operate more efficiently and, particularly, because of technological advance: the invention of new and improved products and production processes.

The next most important contributor to our material standard of living is "labour utilisation": the proportion of the population that's of the right age to be in the labour force (often taken as everyone aged 15 to 64), the proportion of people of working age who actually are in the labour force, the proportion of these who are employed rather than unemployed, and the average hours worked by people employed (many of whom will be only part-time).

The standard story from economists is that the nation's income increases when we produce more goods and services. But it's not quite that simple. It's not just how much we produce, it's also what that is worth when we sell it to foreigners so we can buy what we want from them.

About 10 years ago the world started paying us a lot more for our minerals and energy - we called it the resources boom - and this increased the income we derived from the stuff we were producing. As Lowe puts it, "over time we have been able to buy more and more flat-screen televisions for each tonne of iron ore that we have sold overseas".

Economists call this an improvement in our "terms of trade" - prices we receive for exports relative to the prices we pay for imports. And the main reason our standard of living rose by a high 2.3 per cent over the past 13 years is the big improvement in our terms of trade.

It contributed about 0.8 percentage points of that 2.3 per cent growth, more than making up for a weaker rate of improvement in the productivity of labour.

But, as we all know, the fabulous prices we were getting for our coal and iron ore started falling back a year or two ago, and Treasury expects them to fall a fair bit further. Indeed, it expects the deterioration in our terms of trade to subtract about 0.5 percentage points from the annual growth in real national income per person.

And there's a second factor we'll have going against us. Until recently, we've been enjoying a "demographic dividend" as the population of working age grew faster than the overall population (mainly because of the falling rate of fertility).

Over the 30 years to 2010, the proportion of the population aged 15 to 64 rose from a bit more than 64 per cent to a peak of about 67 per cent. But now, with the continuing retirement of the baby-boomers, it's projected to fall to about 62 per cent over the coming 30 years.

So whereas until now the demographic dividend has contributed to the rate of improvement in our standard of living, over the coming decade demography will subtract from that rate (we'll have fewer producers relative to consumers).

Now, there's nothing we can do to stop world minerals prices falling back and not a lot we can do to delay the retirement of the baby-boomers. So, ready for the commercial message from your friendly econocrats?

Lowe says that "over the next decade or so, if we are to achieve anything like the type of growth in real per capita income that we have become used to, then a substantial increase in productivity growth will be required.

"If this lift in productivity growth does not take place, then we will have to adjust to some combination of slower growth in real wages, slower growth in profits, smaller gains in asset prices and slower growth in government revenues and services."
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Wednesday, November 27, 2013

Election well over, now for the truth

For three years Tony Abbott and company told us all our political problems were caused by Labor, and if only we elected the Coalition our problems would be no more. For three years Labor told us the budget would be back to ever-growing surpluses in next to no time.

And for six years - which coincided with our biggest boom since the Gold Rush - both sides of politics told us Australian families were having terrible trouble coping with the rising cost of living.

They encouraged us to feel sorry for ourselves, accepted the blame for the heavy burdens we were labouring under, and implied they could do more to help.

What they didn't tell us was the truth: that for most of us, wages and pensions were rising faster than the cost of living - meaning our standard of living has actually been improving - but that this was due partly to the resources boom, which couldn't last, and partly to the government doing more for us in the budget than it could afford to go on doing unless we were prepared to pay a lot more tax.

In the recent election campaign both sides promised a much enhanced scheme to help the disabled and significantly increased funding for schools. To these Abbott added more generous paid parental leave, abolition of the mining tax and abolition of the carbon tax.

What they didn't tell us was that, when you go out beyond the next four years, they had no way of paying for their promises on top of all their existing commitments, which will get ever-more expensive.

So the stories we're hearing now of the federal and state governments' longer-term budget problems must be coming as an unpleasant surprise to a lot of people.

First we had a Productivity Commission report reminding us that increased spending on age pensions, age care and healthcare (for everyone, not just the increasing proportion of old people) - not to mention the cost of superannuation tax concessions - would put growing pressure on the budget, and do so at a time when a smaller proportion of the population was working and paying income tax.

The commission recommended that the age pension age be phased up to 70 and that old people who own their homes be required to borrow against them to help cover the cost of their aged care.

Then we had a report from Melbourne's Grattan Institute estimating that the combined federal and state government budget deficit is likely to grow to $60 billion a year over the coming 10 years.

The institute provided a menu of tax increases for the politicians to pick from: broadening the goods and services tax to cover food and private spending on health and education, removing the tax-free threshold for payroll tax, getting rid of the health insurance tax rebate, restoring the indexation of petrol excise, making the family home subject to capital gains tax, eliminating the 50 per cent discount on the gains tax, or getting rid of negative gearing.

On the spending side, the pollies could cut spending on transport infrastructure, halve industry support, increase university HECS fees, greatly increase school class sizes, cut defence spending or make savings on healthcare.

But Grattan zeroed in on retirement income support. It's already planned to phase up the age pension age to 67 by 2023, but the institute proposes lifting it to 70 by 2025. It's already planned to lift the minimum age for access to superannuation from 55 to 60 in 2024, but the institute proposes lifting it to 70 by 2035. These two measures would save about $12 billion a year.

It suggests including the family home in the assets test for the age pension (saving about $7 billion a year) and reducing the tax concession on super contributions for higher income-earners (saving $6 billion).

This story that the budget will come under pressure is nothing new. We've already had it from three reports prepared by Treasury, from previous Productivity Commission reports and many others.

So let me ask you: What sort of conclusions and recommendations do you expect the Abbott government's commission of audit to come up with? My guess is, not very different to what we've been hearing - though, since it has been contracted out to the Business Council, it may go out of its way to direct the pain away from big business and the well-off.

Since we have to make a lot of tough choices if we're to avoid the North Atlantic economies' record of racking up ever-growing budget deficits and debt for decade after decade, I think pushing back the retirement age makes a lot of sense - more sense than many of the other items on the list.

The already retired and all those not far off retirement wouldn't be affected. But the notion that, despite ever-greater longevity, better health and less physical work, we should remain free in perpetuity to live in taxpayer-funded retirement for 30 years or more is insupportable.

For at least the past six years self-centredness has reigned supreme, with everyone - from big business to alleged battlers - demanding the government do more for them, but insisting others pay for any improvements.

It can't go on. Let's hope Tony's got the ticker to turn things around - and do it fairly.

Read more >>

Monday, November 25, 2013

Budget will test Abbott's mettle

Will the Abbott government ultimately be judged a great reforming government or the worst money manager since Whitlam? In a delicious irony considering all the phoney outrage Abbott & Co expressed on the subject in opposition, this judgment will turn on how they respond to the budget's deep structural problems.

That conclusion leaps out from John Daley's latest budget report for the Grattan Institute. Normally, governments muddle through, taking some tough measures but not enough. In this case, however, Tony Abbott will need to take a lot of tough decisions or be judged a failure who ran a permanent budget deficit and incurred ever-mounting public debt because he lacked the guts to make us pay our way.

Daley finds that, on existing policies, federal and state governments face a decade of structural (operating) budget deficits, which by 2023 could reach 4 per cent of gross domestic product, or $60 billion a year in today's dollars.

About a quarter of this $60 billion arises from the Coalition's election promises. Some of these - the disability scheme and increased education spending - were common with Labor, but not the replacement of the carbon tax with "direct action" (which adds $5 billion a year), nor the more generous paid parental leave scheme.

Three-eighths of the $60 billion arises from the projected increase in spending on healthcare. This comes not so much from ageing as from the unceasing increase in both the supply of and the demand for ever-more-effective, but ever-more-expensive health technology.

One-eighth of the $60 billion arises from "welfare" - mainly, the sad fact that we won't be able to keep widening the income gap between sole parents and people on the dole, and the rest of us, including even people on the pension.

That leaves about a quarter of the $60 billion explained by the likelihood that our return to normal cyclical conditions will involve significantly lower prices for mineral exports and thus lower tax collections.

We can't grow our way out of this deficit. Being "structural", it already assumes the economy is back to growing normally. And above-average growth has much the same effect on both sides of the budget.

With one exception, the only way a structural deficit can be reduced is to make explicit decisions to cut spending or increase taxes. Worse, you have to resist the temptation to make any further unfunded spending or tax-cut decisions just to stop the structural deficit getting bigger.

The exception is bracket creep, which Daley estimates could contribute about $16 billion a year to closing the $60 billion gap. No doubt we'll get a lot of creep, though you can't avoid income-tax cuts for a decade.

Daley's report explodes some budget myths. One dear to the Coalition's heart is that the problem can largely be fixed by eliminating "waste and extravagance", including a bloated public service and (narrowly defined) middle-class welfare.

Sorry, there just aren't enough savings in anything you could do that is remotely feasible. You're talking chickenfeed.

Then there's business' dream that the solution is simple, if a little difficult politically: just cut government spending to fit (and cut company tax while you're at it). When last week's report card from the International Monetary Fund appeared to advocate "sizeable cuts in projected spending", the usual suspects raised a rousing cheer.

Sorry, leaving aside changes to the age pension, the best Daley can come up with on the spending side would produce savings of just $25 billion a year.

These would require reducing spending on infrastructure by a third, halving federal and state industry support, increasing university HECS fees, greatly increasing school class sizes and getting rid of the industry subsidies hidden in the pharmaceutical benefits scheme and defence spending (think subs).

The truth no one wants to know is that we won't get the budget back to structural balance without explicit tax increases. Daley shows, however, we could go a long way by getting rid of some inefficient and unfair tax expenditures, such as the capital gains tax exemption for the family home, the 50 per cent gains-tax discount and negative gearing (worth $22 billion a year in total).

But Daley's big one is retirement income support. Phase up eligibility for the pension or access to super to 70 and save $12 billion a year. Include the family home in the age pension assets test and save $7 billion. Make the super contributions tax fairer and save $6 billion a year.

What's that? You don't see Abbott and Joe Hockey doing anything much on that list? Well, stand by for endless budget deficits and ever-mounting government debt. No guts, no avoiding disgrace.
Read more >>

Saturday, November 23, 2013

Outlook for us and the world is sombre

Australia and the world are experiencing a Micawber moment. The economic prospects aren't reassuring, but there's not a lot we can do except hope something will turn up. Wherever you turn, the outlook is for continuing sub-par growth.

According to Dr Min Zhu, a deputy managing director of the International Monetary Fund, in Australia this week, the post-global crisis growth cycle may be coming to an end. At the peak of the crisis in late 2008, most countries gave their economies enormous injections of fiscal (budgetary) and monetary (interest rate and liquidity) stimulus to get them moving.

It worked. After an unprecedented contraction of 0.4 per cent in 2009, gross world product grew by 5.2 per cent the follow year, by 3.9 per cent the year after, then 3.2 per cent last year. Notice it running out of steam? At this late stage it's expected to slow further to 2.9 per cent this year.

If 2.9 per cent doesn't sound too bad, remember the world economy's long-term average rate of grow is 3.5 per cent a year.

In last month's world economic outlook document, the fund warns that "the major economies must urgently adopt policies that improve their prospects; otherwise the global economy may well settle into a subdued medium-term growth trajectory".

Trouble is, Zhu says most countries - rich and poor - have little "space" left for further fiscal or monetary stimulus. Indeed, the policy action the fund is calling for is more structural than cyclical: "strong plans with concrete measures for medium-term fiscal adjustment and entitlement reform" in the case of the United States and Japan, while the euro area "must develop a stronger currency union and clean up its financial systems".

As for the emerging market economies, many of them "need a new round of structural reforms". China, for instance, "should provide a permanent boost to private consumption to rebalance the growth of demand away from exports and investment".

Well that's fine and dandy. But though structural reforms that improve the functioning of the economy may ultimately have a big payoff, it usually takes ages to come through. And often there are costs up-front.

In the meantime the world's left, like Mr Micawber, hoping we turn out to be luckier than the forecasters expect. And the outlook for our economy isn't all that different.

Reading from a graph in the presentation to the Australian Business Economists' annual conference this week by Dr David Gruen, at the time of the pre-election economic update Treasury was expecting growth of 2.6 per cent this year, improving to 2.7 per cent next year.

That compares with the economy's "potential" growth rate of about 3 per cent - the rate needed to hold unemployment steady. So we can expect a continuing rise in joblessness. And the boss of Treasury, Dr Martin Parkinson, said this week that the prospects for the economy had deteriorated a little since the election.

The pundits seem agreed that the economy could return 3 per cent growth in 2016. But that's just the nice way of saying we look like having to endure three years of sub-par growth. Beaudy.

In theory, we do retain "space" to further stimulate demand with either lower interest rates or increased government spending. But rates have already been cut a long way, and the Reserve Bank seems likely to avoid another cut while we see what difference those earlier cuts make.

As for the budget, it has been in deficit for four years already, so no one is keen to go any deeper. At this stage the Abbott government is following the Labor government's policy of avoiding taking measures to hasten the budget's return to surplus - which would, in any case, be counterproductive to some extent at a time when the economy's weak.

But some of the noises Joe Hockey has been making suggest he's preparing to step in with big spending on infrastructure should the end of the mining investment boom cause a much bigger hole in overall demand than we're expecting. Replacing heavy investment in mining with heavy investment in infrastructure would make a lot of sense.

The main thing we are hoping will "turn up" is a turn down in the dollar. Even the fund said this week it believed the dollar was overvalued by about 10 per cent. An exchange rate with the US dollar in the mid-80s would do a lot to stimulate our trade-exposed industries.

Gruen reminds us that, whereas through most of the noughties exports of resources made a contribution to annual growth in real gross domestic product of about 0.4 percentage points, over this year and the next two or three they will contribute well over 1 percentage point.

The decline in mining investment - which itself will make a big subtraction from growth - will also lead to a decline in imports, since mining investment involves a lot of spending on imported capital equipment. That's a saver.

And for those who worry we may be blowing up a housing bubble, Gruen advises that the median capital-city house price has been roughly steady at four times average household disposable income for the past decade and at present is a fraction below four.

If you look at the graph you don't find the ratio has been steadily climbing over the years. Rather, it was a bit less than three times during the 1990s, but then jumped to four times in the early noughties and has stabilised there.

What happened in the early noughties to bring about this change? The return to low inflation and, with it, low nominal interest rates for home loans. This fall greatly increased the amount banks were prepared to lend people on an unchanged income. Australians used this increase in borrowing power to bid up the prices of our housing.
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Wednesday, November 20, 2013

How we lost our way on climate change - sorry, kids

I don't have grandchildren but I'm hoping for some, someday, so this column is for them. I want you to know that although, in the mid-teens of this century, Australians elected a government that wasn't genuine in its commitment to combating the effects of climate change, and that even abolished the main instrument economists invented for that purpose, I never accepted this complacency.

Partly because that government's predecessors had done such a poor job of introducing effective measures - and even a party known as the Greens played its cards all wrong - the nation lost its resolve and allowed its original bipartisan commitment to decisive action to be lost.

The minority of people who doubted the scientists' advice that the globe was warming combined with libertarians - who, as a matter of principle, oppose almost all arguments for intervention by government - to persuade the Liberals to break with bipartisanship.

If the Liberals under their new leader, Tony Abbott, had opposed action against climate change outright, Liberal voters who accepted the need for action would have been forced to choose between the party and their beliefs.

Instead, Abbott focused his opposition on the Labor government's main instrument for gradually bringing about a reduction in emissions of carbon dioxide and other greenhouse gasses, an emissions trading scheme whose price would be fixed by the government for the first year or two.

Abbott insisted the Coalition remained committed to Australia's international undertaking to reduce emissions by at least 5 per cent below 2000 levels by 2020, and by 15 per cent or 25 per cent provided other countries were taking comparable action.

The big difference was that, rather than using Labor's "carbon tax" to achieve the target, the Coalition would rely on "direct action", such as offering monetary incentives to farmers and others to reduce emissions.
This left Abbott free to run an almighty scare campaign about how Labor's "great big new tax on everything" would greatly increase the cost of living for ordinary Australian families and impose big costs on Australian businesses, which would impair their ability to compete.

Abbott associated with outright climate-change deniers and said things that seemed to brand him as one of them, while always adding, sotto voce, that he accepted human-caused climate change and the need to do something about it.

Apart from attracting voters away from Labor and its frightening carbon tax, the result of making climate change an issue of party dispute was to give Liberal supporters a licence to stop worrying about climate change - if the leaders of my party aren't worrying, why should I? - while providing a fig leaf for those Liberals who retained their concern.

The business lobby groups' initial position had been: if it's inevitable we do something, let's get on with it and make future arrangements as certain as possible. But with their side of politics inviting them to put their short-term interests ahead of the economy's long-term health, most business people found it too tempting to resist.

To be fair, some businesses stuck with their schemes to reduce their own emissions and some pressed on with repositioning their business for a world where the use of fossil fuels had become prohibitively expensive as well as socially disapproved of.

You will find this hard to believe, but in the mid-teens, it was still common to think about "the economy" in isolation from the natural environment which sustained it. Economists, business people and politicians had gone for two centuries largely ignoring the damage economic activity did to the environment.

The idea that, eventually, the environment would hit back and do great damage to the economy was one most people preferred not to think about. At the time, it was fashionable to bewail the lack of action to increase the economy's productivity. Few people joined dots to realise the climate was in the process of dealing a blow to our productivity, one that would significantly reduce the next generation's living standards.

At the time, we rationalised our selfishness - our willingness to avoid a tiny drop in our standard of living at the expense of a big drop in our offspring's - by telling ourselves half-truths and untruths about the global nature of climate change.

We told ourselves there was nothing Australia could do by itself to affect climate change (true), that at the Copenhagen conference in 2009, countries had failed to reach a binding agreement on action to reduce emissions (true) and that the world's two biggest polluters, China and the US, were doing nothing much to reduce their emissions.

We had no excuse for not knowing this was untrue because successive government reports told us the contrary. One we got just before the carbon tax was abolished, from the Climate Change Authority, said the two superpowers were stepping up their actions to reduce emissions. "These measures could have a significant impact on global emissions reductions," it concluded.

I recount this history to explain how my generation's dereliction occurred, not to defend or justify it. We knew what we should have done; we chose not to do it. I never fell for any of these spurious arguments.
Did I ever doubt that climate change represented by far the greatest threat to Australia's future economic prosperity? Never. Should I have said this more often, rather than chasing a thousand economic will-o'-the-wisps? Yes.
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Saturday, November 9, 2013

Rent-seeking stymies genuine reform



For most of the past decade I’ve defended Australia’s mining companies and their boom against unreasonable criticism. So I could hardly be said to be anti-mining. But one of my failings is that don’t get any fun out of telling people what they’d like to hear. So when I was asked to speak at the federal government’s annual conference on resources and energy last month I decided to tell the miners a few home truths. This is a shortened version of what I said.

With the change of government I'm sure you're a lot happier about the prospects for the economy and its management, and a lot more confident of a sympathetic hearing from the new government. I wouldn't be so sure.

I suspect the mining industry's lobbying success is reaching its zenith as we speak. It won't surprise me if, looking back on the life of the Abbott government, you come to realise the big gains the industry made actually occurred under the Labor government. They occurred no thanks to Labor, and all thanks to the Coalition, but they occurred in reaction to the policies of Labor as part of Tony Abbott's successful four-year campaign to fight his way back into office.

Why did Abbott immediately oppose the mining tax and promise to repeal it? Because he genuinely believed it would wreck the mining industry and do damage to the wider economy? I doubt it.

He did it primarily because he saw opposing the tax as a popular cause and was hoping for a lot of monetary support from the big miners in the 2010 election.

Why did Abbott set his face against the carbon pricing scheme? Because it was the price of getting the backing within the party that allowed him to wrest the Liberal leadership from Malcolm Turnbull and because he could see what a popular cause it would be to oppose this "great big new tax on everything".

Now, I have no doubt that keeping his promises to get rid of the mining tax and the carbon tax will be among his priorities. But my point is this: having delivered so handsomely for the mining industry, I doubt if he'll feel in any way indebted to the miners.

Indeed, he may well feel he's the one that's owed. Certainly, he'll feel the miners have had enough favours to be going on with.

And it won't surprise me if that's the attitude other industries take: that the miners have had their turn and it's time to give other industries a go.

Does this analysis seem cynical? Sorry, it's just being brutally realistic. We all pursue our self-interest, but we all cloak our self-interest in arguments about how this would be in the best interest of the economy. All I'm doing is stripping away the bulldust.

Most people in business are hoping that with a more enlightened government in power with a big majority in the lower house and a workable Senate after July, we'll see some major economic reform, if not in Abbott's first term then certainly in his second. I think this is an idle hope.

In a prophetic speech he delivered in May - and which he's in the process of expanding into a short book - Professor Ross Garnaut argued that our political culture has changed since the reform era of 1983 to 2000, in ways that make it much more difficult to pursue policy reform in the broad public interest.

"If we are to succeed, the political culture has to change again," he said. Policy change in the public interest seemed to have become more difficult over time as interest groups had become increasingly active and sophisticated in bringing financial weight to account in influencing policy decisions.

"Interest groups have come to feel less inhibition about investment in politics in pursuit of private interests.
"For a long time, these past dozen years, it has been rare for private interests of any kind to be asked to accept private losses in the interests of improved national economic performance.

"When asked, the response has been ferocious partisan reaction rather than contributions to reasoned discussion of the public interest in change and in the status quo," Garnaut said.

I would remind you that, though John Howard's introduction of the GST is a notable exception, many of the reforms of the Hawke-Keating era were achieved with bipartisan support - something that's unthinkable today.

Much of that reform, particularly in taxation, involved packages of measures in which particular interest groups suffered some losses, offset by other gains. As Garnaut argues, and I'm about to demonstrate, this kind of co-operative give-and-take between interest groups willing to accept reforms in the wider public good isn't conceivable today.

My way of making Garnaut's point is that since the reform era of the 1980s and '90s, we've regressed to a culture of rent-seeking. You can see this at the level of the political parties and at the level of the industry lobbies.

When Howard had the courage to propose introducing a GST, Labor saw its chance to regain office by running a populist scare campaign against it, and came within a whisker of winning the 1998 election. At the time it professed to be righteously opposed to such a regressive tax, but when it finally regained power seven years later, the idea of doing something about that supposedly abhorrent regressivity never crossed its mind.

When, in turn, the Rudd government attempted the risky reforms of installing the "economic instrument" most economists recommend for responding to climate change, and rebalancing the tax system by reforming the taxation of mineral deposits and using the proceeds to reduce taxes elsewhere, Abbott lost little time in deciding to take advantage of Labor's vulnerability.

Do you really think the events of the past three years will have no bearing on the Labor opposition's attitude to any controversial reforms Abbott might propose in the next six years, or that Abbott's foreknowledge of this attitude will have no bearing on his willingness to propose such reforms?

The truth is the nation has fought itself to an impasse on controversial reform - of the labour market as well as taxation - and, among the industry lobbies, the miners have played a more destructive role than the rest.

Now, you can respond that the miners did no more than what you'd expect them to do: oppose taxes they perceived to be contrary to their industry's interests. But this is making my point: the reason the outlook for reform is now so bleak isn't solely because the two sides of politics have regressed to short-sighted, self-interested advantage seeking, it's also because the industry lobby groups have done the same thing.

There's nothing new about industry lobbying but in the past dozen years it's become far more blatantly self-interested and far more willing to devote large sums to advertising campaigns to oppose whatever government reforms an industry sees as contrary to its interests. What hasn't yet occurred to many business people - but you can be sure is well understood by the politicians and their advisers - is that when industries lobby governments for favours, or in opposition to new imposts, the various industries are in competition.

It's easy to imagine the government's coffers are a bottomless pit but, in fact, there's only so much rent to go around. As an economist would say, all concessions have an opportunity cost. It's easy to believe all industries could pay less tax if the pollies would only make households pay more tax, but I wouldn't hold my breath waiting for it to happen. I doubt either side of politics would see that as consistent with their own self-interest.

The truth is, when one industry gets in for a big cut, there's less left in the pot for the others. That industries don't understand this simple point about opportunity cost - don't realise they're in competition with each other - is easily demonstrated by the demise of Labor's mining tax package.

Think about the original package: the big three miners were going to pay more tax on their resource rents, but most of the proceeds were going to be distributed to other industries.

In particular, all companies (including miners, big and small) were getting their company tax rate cut by 2 percentage points, small miners were getting a resource exploration rebate, small business was getting instant write-off of most assets, the banks were getting more concessional taxation of depositors' interest income, and the financial services industry was getting its dream of having compulsory super contributions jacked up from 9 per cent to 12 per cent, a one-third increase in contributions.

So three big miners had a lot to lose, but the rest of industry had a lot to gain. So what was the rest of industry's attitude to the resource super profits tax? Didn't like the sound of it.

And what did they do when the miners sought to scuttle the new tax? Precisely nothing.

What happened then? The exploration rebate was to first thing to disappear and, in several stages under Labor, the cut in the company tax rate got whipped off the table.

Now, with Abbott's plan to abolish the cut-down mining tax, the small business concessions are being withdrawn and the phase-up of compulsory super has been deferred for two years.

With all the pressure on the Abbott government's budget, and the super industry extracting a promise from Abbott not to make any further savings on the concessional taxation of super, I'm prepared to bet the two-year deferment will become permanent.

Thus did the rest of business allow the miners to screw them over. And thus did the miners destroy faith in one of the techniques tax reformers believed made major tax reform possible: put together a large package with a mixture of wins and losses and the various industry lobbies keep each other on board in the wider interest.

But it doesn't stop there. When the miners and the rest of business dream of further tax reform under the Abbott government what do they have in mind? Mainly, a big cut in the company tax rate. Do you really see the Abbott government daring to fund such a cut by increasing the GST?

Had the minerals resource rent tax survived and got past its accelerated depreciation phase, the fact that the most highly profitable part of the corporate sector (along with the banks) was paying a lot more tax on its profits would have greatly strengthened the argument for a general cut in the company tax rate. This is particularly so because mining is so heavily foreign-owned. So the absence of the resource rent tax makes a cut in the company tax rate a lot less likely.

One way a cut in the rate could still be afforded is if it was covered by a broadening of the base by the removal of sectional concessions. But the bitter experience of the demise of the mining tax package makes it less likely any government would risk proposing such a compromise.

We can continue going down the road of ever-more blatantly self-interested behaviour by political parties on the one hand and industry lobby groups on the other, but while we do so it's idle to dream of major reform.

What we can do - as the miners have shown - is veto any reform we don't fancy.
Read more >>

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.
Read more >>

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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