Saturday, December 14, 2013

Holden's fate will have little effect on economy

Contrary to appearances, the economy is not falling apart nor has the Abbott government taken leave of its senses.

The threat to the economy from Holden's decision to cease making cars has been greatly exaggerated by those with axes to grind - the opposition, the motor vehicle union and other industry apologists, plus the overexcited media.

The greatest threat comes not from what happens to the car industry - nor from Qantas' plan to lay off 1000 workers - but from the risk that all the talk of job losses could leave people in industries far removed from the troubled sector with an exaggerated impression of their chances of losing their own jobs, prompting them to become more cautious in their spending and housing decisions.

There is no denying the Abbott government is off to a rocky start, with its backing and filling over the Gonski education reforms, its ruminations over continued Australian ownership of Qantas, and its refusal to permit the foreign takeover of GrainCorp casting doubt over Tony Abbott's election-night claim that Australia is now ''open for business''.

What we have had from Abbott is clunkiness. It's been hard to detect the hand of a government that knows what it is doing and where it is heading, let alone one that can articulate its destination and reasons for wanting to take us there.

But its most controversial decision so far - to decline to keep paying the protection money demanded to defer General Motors' departure from production in Australia - offers hope that this is a government with the courage to give genuine leadership, to make the unpopular decisions needed to secure our economic future.

If we want the economy to return to a healthier rate of growth, with rising job opportunities, the answer is for our businesses to find new and better ways to make profits, not for them to become ever more reliant on government subsidies.

It is for us to face up to, and adapt to, a rapidly changing world economy, not use taxpayers' money to try to prevent change, eventually turning our economy into an industrial museum.

If we want the federal budget to be returned to balance without huge hikes in taxation, part of the answer is to stop providing welfare to industries as well as people.

It is understandable for older Australians to be sentimental about the end of car making by our first car maker - even though most of us stopped buying locally made Holdens many moons ago, just as most of us have stopped using Qantas to fly overseas.

How much tax are you prepared to pay for sentimental reasons?

It is also understandable for older Australians to worry about the decline of manufacturing. If we stop making things, where will the jobs come from?

Employment in manufacturing has been falling since the early 1970s, during which time the workforce has doubled. Manufacturing now accounts for only about 8 per cent of total employment.

Do you really believe the remaining 92 per cent of us have phoney, inconsequential jobs? The big jobs growth has been in education, health, community and business services. Where will the jobs come from? That's where. The same thing is happening in all the rich countries.

The prospect is for the rate of unemployment to keep creeping up next year until the effect of record low interest rates causes spending on consumption, home building and business investment to recover and take the place of the now-declining investment in new mines.

What happens in car-making will have a negligible effect on what happens to unemployment everywhere except Adelaide. For a start, few jobs will be lost until the plants close in 2016 and 2017.

It's planned that 2900 jobs will go from Holden, with a greater flow-on to the parts-makers. But car and component manufacturing account for only about 0.4 per cent of total employment.

Even the end of local car-making wouldn't mean the end of cars. Saul Eslake of Bank of America Merrill Lynch reminds us there are five times as many people employed in the wholesaling, retailing and maintenance of cars as are employed building them.

Car-making ended in Sydney in the 1980s. Steel-making ended in Newcastle in 1999. Since then, both cities have not only survived, but prospered.
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Multi-factor productivity not what it's cracked up to be

Figures for the economy's productivity performance haven't looked good for the past decade, causing consternation among economists and business people. But a careful study by the Productivity Commission has failed to find any particular problem, nor anything we could do to make the figures look better.

Productivity is a measure of the efficiency with which the economy turns inputs of labour and capital into outputs of goods and services. Thus productivity is measured as output per unit of input.

The more we can improve productivity the better off we are. We have in fact being increasing it a little almost every year since the Industrial Revolution, and this is what has made us so much more prosperous. So if you believe the goal of economic management should be to increase our material standard of living (which I don't), nothing is more important than ever-improving productivity.

The simplest (and probably least inaccurate) way to measure productivity is to take the quantity of goods and services produced during a period (real gross domestic product) and divide it by the number of hours of labour required to achieve that production.

Doing this each year shows that our "productivity of labour" improved unusually rapidly in the second half of the 1990s, but then showed little further improvement during most of the noughties. Over the past two or three years, however, it has returned to a reasonably healthy rate of improvement.

But you can improve the productivity of labour simply by giving workers more machines to work with. And this tells us nothing about the efficiency with which the economy's physical capital is being used. So in recent years it has become fashionable to focus on a more sophisticated measure called "multi-factor productivity".

This is the growth in real GDP (output) that can't be explained by any increase in inputs of both labour and physical capital. So, in principle, multi-factor productivity represents "technological progress" - the invention of better physical technology and the discovery of better ways to organise the production of goods and services. It's technological advance that does most to raise material living standards.

When you look at our performance over the past few years you find that, though the productivity of labour has been improving at a reasonable rate, multi-factor productivity hasn't improved. It was this that staff at the aptly named Productivity Commission set out to investigate in a study published last week.

They found that the flat performance of multi-factor productivity in the market economy was explained mainly by an actual decline in the multi-factor performance of manufacturing. So they focused their investigation on manufacturing.

Estimates by the Bureau of Statistics show that between 1998-99 and 2003-04 multi-factor productivity in manufacturing improved at a rate of 1.3 per cent a year. But between 2003-04 and 2007-08 it fell by 1.4 per cent a year. Since then (up to 2010-11) it has deteriorated at the slower rate of 0.8 per cent.

Delving further, the researchers found that two-thirds of the deterioration between the first two periods could be explained by just three of manufacturing's eight sub-sectors. From worst to least worse: petrol and chemicals, food and beverages, and metal products.

Trouble is, they could find "no overarching systemic reason for the decline". That is, no problem or problems you could tell the government it needed to fix.

What they found were several factors that made the figures look bad but weren't actually bad themselves, plus one factor we all know about, can't do much about, but have reason to hope will improve soon: the high dollar.

The metal products industry's poor performance was explained mainly by a big expansion in alumina refining capacity which had yet to come on line. Obviously a temporary problem.

The petroleum and chemicals industry's poor performance was explained to a significant extent by increased investment by petroleum refineries to meet new environmental standards. That is, there was an improvement in the quality of their output which the figures didn't pick up.

The food and beverages industry's poor performance was partly explained by a change in consumer preferences in favour of products made in smaller-scale, more labour-intensive bakeries. No probs if that's what the punters want.

In both petroleum and chemicals and food and beverages the poor performance was explained also by reduced use of production capacity, caused largely by the effect of the high dollar in reducing exports and increasing competition from imports.

But now I must give you the product warning economists keep forgetting. Like so many other concepts in economics, multi-factor productivity is simple in principle but as ropey as hell in practice. Putting a number on the concept requires you to make a lot of unrealistic assumptions (perfect competition, equilibrium, for instance) and use statistics that don't accurately measure what they're supposed to measure.

As the researchers acknowledge, multi-factor productivity is measured as a residual: after you estimate the amount of production you subtract an estimate of the amount of labour used and an estimate of the amount of capital used (particularly dodgy) and what's left is multi-factor productivity.

It's what a modeller would call an "error term" - the net result of all the mismeasurement of output, labour input and capital input. So, as the researchers acknowledge, the figures they have used can't be taken as a reliable measure of technological progress.

My word for it is ragbag: technological progress may be in there somewhere, but so will be a lot of other things, real and non-existent.

You can work out the figures for multi-factor productivity, but if they look good you don't know whether they really are, nor why they are. If they look bad it's the same.

What the Productivity Commission's study tells me is that even with figures that look really bad, it can find nothing amiss. Worrying about measures of multi-factor productivity is jumping at shadows.
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Wednesday, December 11, 2013

Trans-Pacific Partnership: we pay more for longer

According to someone called Oscar Ameringer, politics is the gentle art of getting votes from the poor and campaign funds from the rich, by promising to protect each from the other. However, when Tony Abbott spoke at the Business Council's 30th anniversary dinner last week, he was very much in protecting-big-business mode.

"On election night, not quite three months ago, I declared that Australia is under new management and once more open for business," he told the captains of industry. "My business - the business of government - should be making it easier for you to do your business because government doesn't create prosperity, business does.

"Governments' job is to make it easier for good businesses to do their best ... that's why almost everything we've done over the past three months has been to make it easier for Australians to do business."

It's possible, of course, that Abbott didn't really mean all that. Perhaps he was just greasing up business people because they were who he happened to be speaking to. Maybe next week he'll tell a bunch of consumers he's doing it all for them.

It's too early to tell just whose interests the Abbott government is seeking to advance. Maybe it doesn't yet know itself.

But I get a bit twitchy when I hear politicians running the line that what's good for General Motors is good for America.

I worry when I hear allegations that Australia bugged the cabinet room of a friendly nation not in the national interest but in the interest of a particular Australian company. Then that one of the politicians at the time has since become an adviser to the company.

I confess to being concerned about what deal Trade Minister Andrew Robb is doing in our name at the Trans-Pacific Partnership negotiations in Singapore this week.

The partnership is a trade treaty the US wants with 11 other Pacific rim countries: Canada and Mexico, Chile and Peru, Australia and New Zealand, Japan and Malaysia, Singapore, Brunei and Vietnam.

The US has been negotiating the treaty since 2006 in what it has insisted be complete secrecy. Although it has no doubt been consulting with its own big companies, and it's a safe bet our business lobby groups have been briefed about the contents of the treaty and have advised our government on their views and goals, the rest of us aren't meant to know what's going on.

Parliament will have to be told the content of the done deal before it votes to ratify any treaty the government has agreed to, but that's all. It's "need to know" and you, dear voter, don't need to know. Leave it to the adults.

Well, not quite. Last month one of the draft treaty's 29 chapters, on intellectual property, was published by WikiLeaks.

This week one country's detailed description of the state of negotiations was leaked. So we know a fair bit about what we're not supposed to know. And what we know isn't terribly reassuring.

What I know about the US government's approach to trade agreements - which doesn't seem to have changed since the deceptively named free-trade agreement we made with it in 2004 - is that its primary objective is to make the world a kinder, safer place for America's chief export, intellectual property: patents, copyright and trademarks - in the form of pharmaceuticals, films, books, software, music and much else.

To this end, the length of copyright would be extended beyond the 70 years to which it has already been extended, and copyright infringement would be made a criminal offence. It would be made easier for pharmaceutical companies to artificially extend the life of their patents and frustrate the activities of others wishing to produce generic versions.

It is clear this would greatly benefit America's big entertainment, software and drug companies.
What's equally clear is that it has no economic justification, being simple "rent-seeking"; government intervention in markets to enhance the profits of particular companies.Rupert Murdoch's 21st Century Fox would be a prime beneficiary.

Since Australia is a net importer of intellectual property, our government ought to be in no doubt the Americans' demands are contrary to our economic interests.

The leaks reveal many dubious demands by the US, but none more so than its promotion of "investor-state dispute settlement" provisions, which would allow foreign companies to pursue legal actions against our government in foreign tribunals if, for example, it were to introduce policies they considered contrary to their interests.

This would give foreign companies an advantage local companies didn't have. The Productivity Commission found such provisions offered few benefits, but considerable policy and financials risks. The former Labor government had a blanket ban on agreeing to such clauses, but Robb's approach is more flexible.

Why would any country agree to such unreasonable demands? Because, in exchange, the Americans are holding out the promise of greatly enhanced access to their markets - in our case, for sugar and beef.

So what we're not supposed to know is that, if the rest of us get sold out, it will all be in aid of Australian farmers. The trouble with running the economy to benefit business is you end up harming some to help others.

But not to worry. The leaks suggest agreement on the treaty is a long way off.
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Monday, December 9, 2013

Keating gives Abbott a masterclass

With our neophyte Prime Minister and his Treasurer struggling to find their feet - and a direction to travel in - let's hope they've been watching the ABC's interviews with Paul Keating. If not, they're out on DVD this week.

For those of us who lived through the Hawke-Keating government's extraordinary 13 years - and those who didn't - Kerry O'Brien's four interviews are a reminder of Keating's indisputable claim to be our greatest, most reforming, treasurer.

If you're tempted to doubt that, consider Business Council president Tony Shepherd's description of our economy in the early 1980s. Keating had described it as a "moribund, inward-looking industrial graveyard" and he'd been right, Shepherd said.

"We had a fixed exchange rate, tariffs [on imports] were still high, we were frightened of Japanese investment ... our financial system was tightly regulated, our industrial relations system was centralised, complex and unproductive, and just about every service was provided by the public sector. State ownership extended to banks, insurance, telecommunications, airlines, ports, shipping, dockyards, electricity, gas etc," Shepherd said.

Keating was the instigator of virtually all those reforms. And though many of them weren't opposed by the Coalition opposition, they were radical reforms - brave steps into the unknown - controversial in the community, including among many Labor voters.

O'Brien's interviews reveal Keating in all his strengths and weaknesses. His self-congratulation ("there's nothing there to be humble about"), bravado ("what I love about the Road Runner is he runs that fast he burns up the road behind him; there's no road left for the others"), colourful language ("a pimple on the backside of progress"), disposal of people who got in his way (Bob Hawke, for instance) and revenge against supposed enemies ("don't get mad, get even" - including with Fairfax).

But no leader of this country since John Curtin has more cause for self-congratulation than Keating. No leader is without character failings and Keating's were outweighed by his contribution.

If Tony Abbott and Joe Hockey want their chapter in Australia's economic history to be half as glorious as Keating's there's much they could learn from him, starting with his clear sense of purpose. "I had to make sure this slothful, locked-up place finally became an open, competitive economy."

His vision was of "an efficient, competitive, open, cosmopolitan republic, integrating itself with the Asian region".

"To do what's right and good gives you the surge. Without the surge, what are you? You're just mucking around with tricky press statements, appearances and 'doorstops'." - "You make the political strategy around good policy rather than around trickery."

Keating was a man of courage. "I always believed in burning up the government's political capital, not being Mr Safe Guy." - "You're nobody until you attract a good set of enemies." - "If you run hard enough and fast enough for a great change you'll get it." - "Statecraft and nation building are about taking the risks and moving the country on."

And a man of toughness. "Nations get made the hard way; nation building is a hard caper." - "You've got to elbow your way through." - "In the end, if you want to get the changes through you've got to hold your nerve and squeeze the system."

Does that sound like any present politician? Last week Hockey said he had an "economic plan" focused on building economic growth. Great. At last. What is it?

"It is focused on getting rid of inhibitive taxes and inhibitive regulation that undermines our capacity to be at our best. We need to speed up the Australian economy and ... if we repeal the carbon tax, it will add to economic growth ... when we get rid of the mining tax it sends a clear message to the world that we need mining investment."

Really? That's the best you've got - to undo the reforms of the previous government? To move to a less economically efficient instrument against climate change and undercharge mainly foreign-owned mining companies for their appropriation of our non-renewable resources? That will balance the budget? That's what will lift productivity? Seriously?

According to Abbott last week, "the challenge is always the same: to build the strongest possible economy with lower taxes and less red tape leading to higher productivity and stronger economic growth ... my business - the business of government - should be making it easier for you to do your business".

Really? Easy as that, eh? No need for courage or toughness. No need to do anything that won't win a vote of thanks from the Business Council.
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Saturday, December 7, 2013

Mining still driving economy - slowly

The economy performed poorly in the September quarter, but that's OK. It was all Labor's fault, but now Labor is out. From here on it will be the Coalition's watch and everything will be much better. Or not. At least from here on Joe Hockey will be talking the economy up - as a treasurer should - not talking it down.

The national accounts we got this week show the economy grew by only 0.6 per cent in the quarter and by 2.3 per cent over the year to September. According to Hockey this shows "an economy that is growing below trend, with a soft labour market, cautious consumers and plateauing business investment".

That's the frankest assessment we're ever likely to get from the man. Although no one can say with confidence what the future holds, the best guess is that, this time next year, the economy won't be growing much faster than it is now. The non-mining economy should have picked up a bit by then, but this may be offset by big falls in mining investment spending.

As it is now, the national accounts show little strength in the rest of the economy, leaving mining accounting for what growth we did get. Starting with consumer spending, it grew by just 0.4 per cent in the quarter and by 1.8 per cent over the year to September.

That's well below its trend rate of about 3 per cent and is explained mainly by weak growth in employment (a smaller increase in the members of households earning incomes) and slower growth in wage rates. Households saved 11 per cent of their disposable income, roughly what they've been saving for three years.

Overall, home building activity fell by 0.5 per cent in the quarter to grow by just 1.7 per cent over the year, but this was because another fall in spending on renovations outweighed weak growth in the building of new homes.

The fall in renovations is surprising: usually when the buying and selling of homes picks up - as it has - renovations pick up as sellers tidy up for a sale and new buyers undertake more extensive changes.
We've seen an increase in council building approvals that's yet to show up in actual building activity, so perhaps housing will make a bigger contribution to growth in the coming year.

Overall, business investment spending increased by 1.1 per cent, but fell by 2.5 per cent over the year. Within this, mining investment rebounded in the quarter, but still looks like it reached its peak last year. Kieran Davies, of Barclays bank, says he expects mining investment to make a major subtraction from growth as it returns to a more normal level over the next few years.

Non-mining investment spending was broadly unchanged during the quarter and down about 4 per cent over the year. Davies says business confidence has picked up sharply, and this normally leads to increased investment, but the delay varies and at this stage he's not expecting much of a pick-up until later next year.
"This is because relatively low levels of capacity utilisation suggest companies are in no rush to expand, even though they can borrow at record low interest rates and many firms are cashed up," he says.

Public demand - spending by governments and their authorities - was broadly unchanged in the quarter, after rising by 0.7 per cent the previous quarter. Within the lack of change overall, however, a 5.5 per cent fall in public investment spending was negated by a 1.1 per cent rise in public consumption spending (mainly public service wages).

Davies says the fall in investment was driven by lower state capital works spending, but this "could turn around later next year and into 2015" because Hockey is encouraging the states to spend more on infrastructure and may introduce some new arrangements to help the states fund this investment.

The volume of exports grew by 0.3 per cent during the quarter and by 6.1 per cent over the year, while the volume of imports fell by 3.3 per cent during the quarter and 3.7 per cent over the year.

Most of this is explained by mining. Bulk commodity exports are up about 15 per cent over the year, while the fall in mining investment - which is "import-intensive" - accounts for the fall in import volumes.

This means "net exports" (exports minus imports) account for more than all the growth in the quarter, and contributed 2.1 percentage points of the 2.3 per cent growth in real gross domestic product over the year.

Who said the resources boom was over? Developments in the mining industry will go on having big effects on the economy for a long time yet. It won't be long, however, before the negatives exceed the positives. That is, before the decline in mining investment spending (even net of the helpful decline in imports of capital equipment) exceeds the gain from increasing exports of minerals and energy as the new mines and natural gas facilities come on line.

And don't forget the quarter saw a further, mining-driven deterioration in our terms of trade - export prices relative to import prices - of 3.3 per cent, taking the total deterioration since the peak in 2011 to 17.7 per cent. This reduction in our real income contributes to the explanation of why consumer spending has been weak.

Hockey is right when he says other indicators - retail sales, building approvals, business and consumer confidence - have improved since September. And it's reasonable to hope this will lead to a modest improvement in consumption, home building, business investment and other aspects of the non-mining economy.

But we know there will be big falls in mining investment, which could offset most of the gain. There's not a lot Hockey can do about that between now and then. Even infrastructure spending takes a long time to get going.
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Wednesday, December 4, 2013

How patients and taxpayers lose out to chemists

Sometimes the good news just doesn't get through. Did you know, for instance, that the prices of three widely used medicines fell from the start of this month, meaning more than 850,000 Australians will be paying less? As federal Health Minister Peter Dutton announced, this is happening because of a wise policy instituted by the Howard government in 2007.

The saving on the most frequently prescribed medication on the pharmaceutical benefits scheme - the anti-cholesterol drug atorvastatin (known as Lipitor before its patent expired) - will range between $5.58 and $12.51 a script, depending on which brand the chemist gives you.

For olanzapine - used for schizophrenia and bipolar disorder - the saving will be up to $6.69 a script. For venlafaxine - used for major depressive disorders - the saving will be $7.03 to $10.60 a script.

But Dutton is too modest. He didn't mention that the wholesale prices of four other drugs have also fallen, reducing the cost to the taxpayer but not the direct cost to patients.

The pharmaceutical scheme requires patients to make a co-payment of up to $36.10 a script (or up to $5.90 for people with concession cards), with the government paying any amount above the co-payment. So the more the price falls below $36.10, the greater the direct saving to patients.

There's just one problem with all this good news. As Dr Stephen Duckett points out in a report for the Grattan Institute, it's not nearly as good as it should be. The price cuts the government has extracted from the drug companies still leave Australian taxpayers and patients paying about 14 times more for those seven medicines than are paid in New Zealand, Britain and parts of Canada.

Duckett - a hugely experienced health economist - estimates that, had our government driven a deal as tough as other governments, patients would be paying less for all seven of them, not just three. The out-of-pocket saving would average about $21 a drug.

Take atorvastatin (a medicine close to my heart; as close as my blood vessels, in fact). The wholesale price of a box of 30, 40-milligram pills has fallen to $19.32 (the price from the chemist would be a bit higher). The equivalent price in Britain is $2.84 and across the Tasman it's $2.01.

If our price came down that far it wouldn't only be ordinary patients who made savings, pensioners and other concession card holders would too.

Remember, even with our subsidy scheme, plenty of people don't take the pills they should because they find it too expensive. (I'm on seven prescription pills; I can afford it, but plenty of people my age can't.)

There was a time when Australians paid less for medicine than most people in developed economies. Now we pay high prices because John Howard decided to go easy on the international drug companies. In its six years in office Labor did little to remove this rort. Why not? Keep reading.

The change came when a lot of widely used medicines came to the end of their patents. A patent gives its holder a monopoly over production of that drug. It can charge a very high price for the drug, one far above its cost of production.

Governments choose to grant patents and so allow overcharging to encourage companies to incur the high costs and risks of developing new medicines.

But when the patent expires, other companies start producing generic versions (all of them still required to meet standards set by the Therapeutic Goods Administration) at very much lower prices.

Governments in other countries determine the lowest price being charged and that is what they pay when buying for their pharmaceutical subsidy schemes. In Australia, however, we decided to go easy on the drug companies. When the drugs first came off patent, we cut the price by only about 30 per cent.

Then Howard introduced a complicated "price disclosure" system, which has the effect of lowering the prices of generic equivalent drugs very slowly. Presumably, if we wait long enough, prices will get down to where they already are in countries that do a better job of protecting their citizens. In the meantime, our government has required us - as taxpayers and patients - to pay far more for our medicines than we need to.

But why? Well, I don't believe it's because many of the drug companies had their headquarters in Howard's electorate. Nor are many of the pills manufactured in Australia. No, it's because the drug companies cut our chemists in on the deal.

Because so many of their patients trust them, chemists are politically powerful. If any government were to cut too far into the taxpayer subsidy our chemists have long enjoyed, the chemists would go on the war path against that government.

Duckett - who knows where the bodies are buried - estimates we are paying more than $1 billion a year too much for generic drugs, with most of that picked up by the taxpayer.

Soon we will get the midyear economic statement with its cuts in government spending. There will be more cuts in the budget in May. Some will affect you.

Joe Hockey will assure you he had no choice. What he will mean is that he's less afraid of you than your chemist.
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Monday, December 2, 2013

What if growth slowed to a trickle and no one cared?

It is the professed belief of almost every economist, business person and politician that Australians require governments to achieve maximum improvement in their material standard of living. I'm not sure that's true - but we're about to find out.

Of late the econocrats have been warning that, unless we undertake major reform, national income will grow a lot more slowly in the coming decade than it did in the past one. According to Dr David Gruen, of Treasury, gross national income per person grew at an annual rate of 2.3 per cent over the past 13 years, but may grow by only about 0.9 per cent over the coming 10 years.

This projected slowdown is explained mainly by the switch from rising to falling prices for our mineral exports - that is, it focuses on income rather than production. It implies only a small slowdown in the underlying rate of growth in gross domestic product (GDP) per person, being based on the assumption that we maintain our long-run rate of improvement in the productivity of labour - an assumption some may question.

Reserve Bank deputy governor Philip Lowe says that, if we don't achieve a substantial improvement in productivity, "we will need 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".

So far, these supposedly dire warnings have met with a giant yawn from the public. And, assuming the slowdown comes to pass, I'm not convinced the public will notice it, let alone care. I doubt that we will retain the national resolve to implement the reforms economists say we need to keep incomes growing strongly, nor am I sure the economists' favourite prescription would work. As for myself, I think slower growth could be a good thing.

Would the punters notice? Maybe not. Despite a decade of above-average growth in real income per person, most people would swear that, whoever had been benefiting from the resources boom, not a cent of it had come their way.

For at least seven years, the popular perception has been that people are struggling to keep up with the cost of living - that is, living standards are slipping. And get this: politicians on both sides, who profess to believe that rising living standards are governments' raison d'etre, have fallen over themselves to agree - contrary to all the objective evidence - that times are tough.

Clearly, they believe failing to agree that times are tough is more likely to get them tossed out than falsely confessing to have failed in their supposedly sacred duty to keep living standards rising.

You may object that the punters' failure to perceive that their living standards have been rising may not stop them correctly perceiving that living standards are now rising only slowly. But consider the United States, where real median household income has been flat to down for the past 30 years because almost all the real income growth has been appropriated by the top few per cent.

Have decades of failure to enjoy rising material comfort caused the American electorate to rise up in revolt? Not a bit of it.

It's significant that the advocates of eternal growth never promote it in terms of rising affluence, but always in terms of the need to create jobs. Barring recession, there's no suggestion production won't be growing fast enough to hold unemployment at about 5 per cent over the decade.

Of course, a recession that led to rapidly rising joblessness would undoubtedly cause great voter disaffection, but that's not what we're talking about.

While it may be possible for the economic, business and political elite to agree their precious materialism has sprung a leak and that something must be done, that doesn't mean they could agree on major reform; it's more likely to lead to continued rent-seeking at the expense of other interest groups. If my share of the pie is bigger, what's the problem?

Economists have no evidence to support their fond belief that the burst of productivity improvement in the second half of the 1990s was caused by micro-economic reform. But even if you share their faith, it's a dismal record: if you undertake sweeping reform of almost every facet of the economy then, 10 to 15 years later, you get no more than five years of above-average improvement. What's more, all the big reform has already been done.

With the global ecosystem already malfunctioning under the weight of so much economic activity, it's time the age of hyper-materialism came to an end and we switched attention from quantity to quality.
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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.
Read more >>

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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