At present GDP is more misleading that usual

I could attempt to explain to you why the Bureau of Statistics is having such embarrassing trouble with its monthly estimate of employment, but I won't bother. It's horribly complicated and at a level of statistical intricacy no normal person needs to worry about.

What this week's labour force figures now tell us is that, though the rate of unemployment has been slowly drifting up since mid-2011 - when it was 5 per cent - it seems to have steadied this year and, using the smoothed figures, has stayed stuck at 6 per cent for the past three months.

This is reasonably consistent with what we know about other labour-market indicators, such as job advertisements and vacancies, claims for unemployment benefits and employers' answers to questions about hiring in the National Australia Bank's survey of business confidence.

It also fits roughly with what the national accounts have been telling us about the strength of growth in the economy. We know that when the economy is growing at its trend rate of about 3 per cent a year, this should be sufficient to hold the rate of unemployment steady.

The accounts told us real gross domestic product grew by 3.4 per cent over the year to March, and by 3.1 per cent over the year to June.

But now let me tell you something that, while a bit technical, is much more worth knowing than the gruesome details of the bureau's problem with the labour force survey.

One of our smartest business economists, Saul Eslake, of Bank of America Merrill Lynch, has reminded us that GDP is only one of various summary indicators of overall economic activity provided by the national accounts. And the economy's peculiar circumstances over the past decade and for some years to come mean GDP is not the least misleading of the various measures.

Eslake says real GDP measures the volume (quantity) of goods and services produced within a country's borders during a particular period. (Actually, it doesn't include the many goods and services produced within households, which never change hands in a market.)

To estimate real GDP the bureau takes the nominal, dollar value of the goods and services produced, then "deflates" this figure by the prices of those goods and services relative to what those prices were in the base period.

We commonly take the value of the goods and services we produce during a period to be equivalent to the nation's income during that period. This easy assumption works for most developed economies most of the time.

But Eslake reminds us that "for an economy like Australia's, the prices of whose exports are much more volatile than those of other 'advanced' economies, abstracting from swings in the prices of exports (and imports) obscures a significant source of fluctuations in real incomes".

We've experienced a series of sharp swings in our "terms of trade" - export prices relative to import prices - over the past decade of the resources boom, which was interrupted by the global financial crisis in 2008-09. For the past three years, of course, mining commodity prices have been falling.

Trouble is, real GDP doesn't capture the effects of these swings. So the values of our production and our income have parted company, as they do every time our terms of trade change significantly. An improvement in our terms of trade causes our income to grow faster than our production, whereas a deterioration has the opposite effect.

This matters because of the chicken-and-egg relationship between production and income: we use the income we earn from our part in the production process to buy things and thus induce more production.

So if our real income slows or falls, soon enough this dampens our production.

However, the national accounts include a measure of overall economic activity that does capture the effects of movements in our terms of trade: real gross domestic income, GDI. It grew a lot faster than real GDP for most of the time between 2002 and 2011, but since then has grown much more slowly than real GDP (a big reason for our slowly rising unemployment).

Next Eslake says that as the resources boom moves into its third and final phase - with mining investment winding down and exports ramping up - real GDP growth will be an even less useful guide to what's happening to domestic income and employment.

This is because maybe 80 per cent of the income generated by resources exports will be paid to the foreigners who own most of our mining companies and who financed most of the new investment.

It's also because the depreciation of Australia's greatly enlarged stock of capital equipment and structures as a result of all the mining investment spending will now absorb a greater share of our gross income.

(A separate issue Eslake doesn't mention is that the highly capital-intensive nature of mining means the increased production of mineral exports will create far fewer jobs than you'd normally expect.)

If you've ever wondered about the difference between gross national product and gross domestic product it's that the former excludes all the income earned on Australian production that's owed to the foreign suppliers of our debt and equity financial capital, making it a more appropriate measure for us given our huge foreign debt and foreign investment in our companies.

If you've ever wondered what the "gross" in GDP, GNP, GNI etc means, it's short for "before allowing for the depreciation of our stock of physical capital".

So gross national income (GNI) is a better measure than gross domestic income (GDI), and net national disposable income (NNDI) is a better measure than GNI.

Which, by the way, explains why real NNDI is used as the base for all the further non-national-accounts-based modifications included in Fairfax Media's attempt to calculate a broader measure of economic welfare, the Fairfax-Lateral Economics wellbeing index, released each quarter soon after the publication of GDP.

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TALK TO NOBEL NIGHT

Economic Society, Sydney, Wednesday, October 8, 2014

Economists - and economic journalists like me - are used to being reminded by science-types that the Nobel prize in “economic sciences” is not a real Nobel. It’s true. Alfred Nobel, said to have had a low opinion of economists, did not include provision for an economics price in his will. Rather, almost 70 years after the real prizes began, a Swedish bank decided to sponsor an economic prize “in honour of Alfred Nobel”. And since it’s the Swedish central bank, able to print its own money, its continued sponsorship has never been in doubt.

So I’m not sure I agree with Paul Oslington that the Nobel is a symbol of the economics professions’ “scientific status”. Only economists delude themselves that economics is a genuine science. In any case, I read that the reference to “economic sciences” is intended as an allusion to the other “sciences” included in the prize, political science and psychology.

Even so, I’m a great supporter of the Nobel in economics, because I suspect it’s one of the few things offering economists an incentive to broaden their horizons beyond the usual mundane preoccupations of the vast majority of academic economists. Economists are so obsessed by competition - both in theory and in practice - I have no doubt that when the prize is awarded to people who’ve ventured into genuinely new areas of economic inquiry, a lot of younger economists are both licenced and incentivated to take up pursuit of that new area. For instance, I don’t doubt that a lot of young economists were motivated to take up the study of behavioural economics after the prize was awarded to Daniel Kahneman in 2002. Similarly, the award to the inventor of experimental economics, Vernon Smith, in the same year, would have done wonders to legitimise experimental economics and encourage young PhDs to take it up. The search for “natural experiments” in economics hasn’t looked back.

What I like about the economics Nobel is that some kink in the selection process - perhaps the participation of members of the Royal Swedish Academy of Sciences, including some non-economists, on the selection committee - means it’s always awarding the prize to people whom most academic economists wouldn’t have dreamt of including on their list of likely recipients and, in some cases, have never even heard off. That no economist had heard of Elinor Ostrom - the first woman to win the prize, in 2009, is an indictment of the inward-looking narrowness of the economics profession. Ostrom studied a distinctly economic topic, the tragedy of the commons. Her problem was that she was a political scientist. And she compounded that moral failing by collecting extensive empirical evidence refuting the conventional economists’ conclusion that the obvious answer to the degradation of the commons was to award property rights. Ostrom found numerous examples of people around the world solving the problem by co-operative arrangements and social sanctions. So obsessed are economists by competition and prices that they can’t see the co-operation that’s in front of their noses.

The other thing I like about the economics Nobel is that the committee keeps overlooking all the people economists are convinced will win it, and giving the prize to non-economists. Ostrom wasn’t the first political scientist to win it; Herb Simon was in 1978. Then there was the mathematician John Nash in 1994 and the psychologist Kahneman in 2002. Oliver Williamson, who shared the prize with Ostrom in 2009, is more sociologist than economist.

Eugene Farma, perpetrator of the great hoax known as the efficient markets hypothesis, was top of the staff-room tipping competitions for decades before his name finally came up last year, but the committee redeemed itself by having him share it with Robert Schiller, the behavioural finance guru who has been saying pretty much the opposite to Farma. That’s almost as big a joke as making Hayek share with the Swedish socialist Gunnar Myrdal in 1974.

How will win this year? I have no advance to offer on Paul’s intelligence. Who should win it? Not the makers of some relatively minor advance in econometric technique, nor the elaborators of the conventional wisdom - such as Farma - but those who’ve made advances with what the profession euphemistically refers to as “market imperfections” - that is, all the unrealistic assumptions on which the neo-classical model rests.

Does any Australian stand a chance? I’ve thought Paul Frijters at the University of Queensland was our only hope - the only Aussie doing genuinely insightful research - ever since I read his path-breaking book, An Economic Theory of Greed, Love, Groups and Networks.

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Why we care about morality - apparently

The good thing about holidays is getting time to read books. I' ll look at all the museos, oratorios, cappellas and duomos in Italy provided I can go back to my book when day is done. On this trip one book I read was Moral Tribes, by Joshua Greene, a young professor of psychology at Harvard.

One of the hottest areas of psychology these days is moral psychology - the science of moral cognition - which seeks to explain why we have moral sentiments and what use they are to us. It' s pretty coldly scientific and evolutionary, which may be disconcerting to readers of a religious disposition.

According to Greene and his confreres - another leading thinker in the area is Jonathan Haight, author of The Righteous Mind, which I' ve written about before - humans are fairly selfish individuals, but we are also highly social animals who like to be part of groups.

Groups, however, require co-operative behaviour, so we evolved moral attitudes to enable us to get along together in groups.

Biologists (and economists) have long stressed the importance of competition between us - survival of the fittest and all that - but it s not hard to see that humans' domination of the planet arises from our unmatched ability to co-operate with each other to overcome problems.

So humans are about competition and co-operation. Economists have schooled us to think of markets as all about competition - between sellers, between buyers and between buyers and sellers - but psychologists see markets as a prime example of human co-operation.

Co-operation through markets allows us to use specialisation - I produce what I' m good at, you do the same and we use the medium of money to exchange the things we ve produced - to increase our combined efficiency in production, leaving us all better off.

Studies have shown that people' s performance in well-known psychology games giving them a choice between selfish or altruistic responses can differ markedly between cultures. Turns out that people from cultures with more developed market systems tend to be less selfish and more co-operative.

So to these scientists, morality is a set of psychological adaptations that allow otherwise selfish individuals to reap the benefits of co-operation within groups.

But why do we want to co-operate within groups? So our group can compete more effectively against other groups.

" Our moral machinery evolved to strike a biologically advantageous balance between selfishness (Me) and within-group co-operation (Us), without concern for people who are more likely to be competitors than allies (Them), " Greene says. This moral machinery includes our capacities for empathy, vengefulness, honour, guilt, embarrassment and righteous indignation, he adds.

The fact is that each of us belongs to a whole host of groups: our family, neighbourhood, workplace, occupation, nationality, ethnicity, religious affiliation, sporting interest, political party and more.

The groups we belong to are the tribes we belong to. We feel a great loyalty to our groups, and greatly favour their interests over those of rival groups. This group selfishness and tendency to see the world as Us versus Them is tribalism.

So, much of the conflict we see around us - both within our country and, as we' ve become more conscious of in recent days, between countries and the groups within them - arises from tribalism.

Much of the conflict between tribes is simple self-interest - I favour my interests ahead of yours, and see them much more clearly than I see yours - but there are also genuine differences in values and disagreements about the proper terms of co-operation. One major source of disagreement in political life is between individual and collective responsibility.

Some disagreement arises from tribes' differing allegiances to what Greene calls " proper nouns" - gods, leaders, holy scriptures and holy places.

Obviously, tribally based morality gets us only so far. What Greene seeks is a "meta-morality" , which can help reduce conflict between tribes rather than just within them. To this end he reaches back to an old idea now out of favour with philosophers: utilitarianism.

(This is of relevance to economists because, though they 've spent the past 80 years trying to play it down, utilitarianism forms part of the bedrock on which the conventional economic model is built.)

According to Greene, utilitarianism answers two basic questions: what really matters and who really matters. What matters most is the quality of our experience. Economists call this " utility" and the rest of us call it "happiness" .

Who matters most is all of us, equally - otherwise known as the Golden Rule.

Thus Greene summarises utilitarianism as " happiness is what matters and everyone' s happiness counts the same. This doesn 't mean that everyone gets to be equally happy, but it does means than no one' s happiness is inherently more valuable than anyone else' s ."

He claims this meta-morality involves a moral system that can acknowledge moral trade-offs and adjudicate among them, and can do so in a way that makes sense to members of all tribes.

It s a nice thought. Somehow I think it will be a while before we measure up to that ideal. But it s always good to have a vision of what we should be aiming for and how we can move towards it.

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Science runs ahead of economists' model

The failings of economists - the bum forecasts and less-than-wise advice they give us about the choices we face - can usually be traced back to the limitations of the basic model that tends to dominate the way they think, the neo-classical model.

The thinking of economists began to ossify in the second half of the 19th century, at a time when the science of psychology was in its infancy. The model was thus consolidated at a time when our understanding of human behaviour was quite primitive.

Unfortunately, the past century of progress in psychology has revealed just how far astray are many of the economic model's assumptions about how humans tick. Although a minority of economists - "behavioural economists" - have sought to incorporate these findings into their thinking, the majority have ploughed on regardless. It keeps the maths simpler.

The model is often criticised, not least by me, for its key assumption that we are always "rational" - carefully calculating and self-interested - and never instinctive or emotional in the decisions we make, but there's another assumption that's equally unrealistic and likely to lead to wrong predictions about how we'll behave.

It's that consumers and businesses always act as isolated individuals in making their decisions, uninfluenced by the decisions those around them are making, except to the extent that the combined behaviour of others affects the prices the individual faces. In other words, the model's "unit of analysis" is the individual - the "representative consumer" or "representative firm".

In truth, humans are highly social animals and our behaviour is hugely influenced by those around us. We evolved to live in small groups, which has left us with a powerful - if often unconscious - motivation to fit in with the group and avoid being ostracised.

We feel most comfortable when we're doing what everyone else is doing; we feel distinctly uncomfortable when we're doing the opposite to everyone else. We feel great loyalty to the groups we belong to, and rivalry and suspicion towards groups we don't belong to.

This means humans - "economic agents" as economists say - are prone to herd behaviour. At the most innocuous level, this makes us heavily influenced by fashion. We like to wear what others are wearing, read what others are reading and watch the movies and TV shows that others are watching.

It's remarkable that the business world could be so conscious of the need to accommodate and, indeed, exploit our susceptibility to fashion while the economists seek to analyse our behaviour using a model that assumes it away.

More significantly, our tendency to herd behaviour affects the behaviour of markets - particularly financial markets - in ways that, though we've seen it happen many times before, almost invariably catch economists unawares.

It's our propensity for "group-think" that does most to explain booms and busts in the sharemarket, but also the upswings and downswings in the economy. We swing from overly optimistic to overly pessimistic, then back again, and we tend to all do it together.

A separate aspect of the model's exclusive focus on the individual is its overemphasis on competition and underemphasis on co-operation. It's actually the human animal's unmatched ability to co-operate in solving problems that has given our species its mastery over the planet.

Human behaviour is composed of competition and co-operation. We form co-operative groups so as to enhance their ability to compete with other groups. But the economists' model captures only one dimension of the process.

The classic example of group co-operation to facilitate competition is, of course, that bedrock of modern economies, the company. Companies - often very large, multinational companies - dominate our economy, but the model tells us nothing about what goes on inside them and economists don't have much to tell us about how the existence of big companies affects the behaviour of markets.

The final and perhaps most important twist that the economic model's focus on individuals imposes on economists' thinking is an inbuilt bias against intervention in markets by co-operation at its highest level, government.

The market of individual consumers and individual (tiny) firms is assumed to be self-sufficient and self-correcting, thus making intervention by government something alien and more likely to make things worse than better.

The reality, of course, is that governments not only need to "hold the ring" - provide the protection of property rights and legal enforcement of contracts - they also need to impose rules that protect the market, and the rest of us, from the consequences of its own herd-driven excesses.

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How mental biases expose us to exploitation

So, you're a regular reader of the business pages and you reckon you're smarter than the average bear when it comes to financial matters. Well, here are some common "biases" to which people fall victim when making decisions about financial products. See if you can put hand on heart and swear you've never made any of these mistakes. If you can, you're a lot smarter than me.

Have you ever overspent on your credit card, or paid off less of it than you know you should? And if you pass that one, try this one: are you confident you're saving enough to ensure your retirement is as comfortable as you'd like it to be?

If you fall short on any of those, you've been affect by what psychologists call "present bias" and behavioural economists call "time-inconsistent preferences" (so in the competition to make your discipline sound smarter than it is, the economists win).

People often succumb to the urge for immediate gratification, thinking too little about the problems this will create for them down the track. It's natural - economists would say "rational" - to value the present more highly than the future. But if you go too far in that direction and end up regretting the choices you made, you've overvalued the present and undervalued the future, making your preferences inconsistent over time.

Most of us have a self-control problem in some field or other. People who are overconfident about their ability to control themselves in the future - to, say, manage heavy repayments - will make their lives more of a pain than they need to be.

Those who are more realistic often use "commitment devices" to impose self-control on themselves. The most extreme example is to cut up your credit card. Compulsory superannuation contributions for employees are a kind of government-imposed commitment device to help us save for retirement - which may be why so few people object.

Businesses exploit our self-control problems by, say, designing a gym subscription that seems cheap, but only if we keep using it for the length of the contract. Or by starting a credit card or home loan with a low interest rate (known in the trade as a "teaser" rate) but then jumping to an overly high rate.

Have you ever delayed moving to a better bank account, or putting some of your savings in a term deposit paying a higher interest rate? The experts call this "procrastination" (now that's a surprise) and class it as a version of present bias.

Examples are legion: deciding to cancel something but not getting around to it, not checking to see if the accounts and the loans and phone contracts you have are still the best available, or not putting much work into searching for the best deal in the first place.

This, too, leaves you open to exploitation by businesses. Some offer a "free trial" while knowing few people will cancel the deal when the paying period begins. Even requiring cancellation by post exploits our inertia.

Have you ever driven a hard bargain to buy a new car, but then gone overboard buying extras like rust-proofing, window-tinting or an improved security system? Have you ever bought a new TV or computer, then been sold extended warranty insurance?

Have you ever hung on to shares now worth less than you paid for them, hoping they will come good and you won't have to accept you made a bad decision to buy them?

If so, you've fallen victim to the biases of "reference dependence" in the first case and "loss aversion" in the second.

It's virtually impossible to look at something and decide what you think about it without consciously or unconsciously comparing it with something else. When buying a car, we compare and contrast all the ones we could buy. Failing that, we compare the one we're thinking of buying with our old one. If we don't have an old car to compare with, we compare having one with going by bus.

Comparisons are almost unavoidable. But we're so dependent on having something else to compare with - use as a point of reference - that if a sensible comparison isn't available we'll use one that makes no sense at all.

An old experiment asks people to estimate how many African countries are members of the United Nations. Most people have no idea. But if, before or while asking the question I mention 60, many people will seize on that number. Do I reckon the number of countries is more or less than 60? How much more, or how much less? That's an easier question to answer.

This way of making decisions is known as "anchor and adjust" and all of us use it all the time, consciously and unconsciously. Trouble is, 60 was a number plucked from the air. Experiments show that if you mention 100 rather than 60 before asking the question you get higher answers.

Point is that our reference dependence makes us easy meat for clever salespeople. We go overboard buying extras for our new car because they all seem so cheap relative to the huge sum we've just forked out to buy the car.

Likewise with extended warranties, which are notoriously overpriced for what little you get back. Anyone wanting to buy "peace of mind" is usually overcharged.

It's an empirical fact that most of us hate making losses much more than we love making gains. By about two to one, they say.

This explains why we do silly things like hanging on to dud shares we should sell - and then should put the proceeds into something with better prospects of gain.

These examples come from a report on behavioural economics prepared by Britain's new Financial Conduct Authority, which has been charged with finding ways to prevent businesses taking advantage of our lack of rational thinking. Good idea.

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THE ECONOMIC CASE FOR A MORE EQUITABLE AUSTRALIA

October, 2014

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Mixed progress on reform of power prices

Do you think you're paying too much for electricity? Would you like to see an end to hefty annual price rises, maybe even a fall in prices that goes beyond the abolition of the carbon tax? Well, be patient. The econocrats are working on it.

It may surprise you that they've been in the process of reforming electricity prices for the best part of 20 years, and they're far from finished. They got part of the power system working well, had a bad slip with another bit, and the jury's still out on a third. But they're working away and are confident of success - eventually.

The national electricity market - covering all of Australia bar Western Australia and the Northern Territory - is actually a creation of our econocrats, their grand experiment in market competition.

Before this, we had separate, state-owned monopolies that charged us pretty much what they wanted to charge, particularly because our demand for power kept growing every year. The reformers' bright idea was to link up all the eastern and southern states and turn them into a market by making all the individual power stations compete to feed electricity into the national grid at the lowest prices possible.

Buying the power at the other end of the grid would be various electricity retailers, which would deal directly with households and business users. These, too, would be required to compete with each other to win our business, since we'd be free to buy our power from whichever retailer we chose.

Linking the power stations in the wholesale market with the retailers supplying power to you and me would be the high-voltage transmission and lower-voltage distribution network (the "poles and wires", as pollies keep calling it).

Since it would never be economic to build rival networks, this would have to stay as a monopoly. And being a monopoly, whether it was sold off or remained government-owned, the prices it charged the retailers - and they passed on to us - would need to be closely regulated to prevent rip-offs.

The reform of the first part of the system has worked really well. Competition between the electricity generators has been cut-throat, prices haven't changed much over the years and no power stations are making excessive profits.

But the cost of generating the electricity makes up only about 30 per cent of the retail prices we pay. The big problem has been that faulty rules have prompted the regulators of the network operators' charges to grant them excessive increases, to the point where "network charges" now explain about half of retail power prices.

It's five years of these big increases, much more than the carbon tax or the renewable energy target, that have caused retail prices to grow so fast. A big part of the problem is that, about four years ago, the demand for electricity, which had been growing every year for a century, stopped growing and started falling.
It fell mainly because of new laws requiring appliances to be more efficient in their use of power and because all the fuss Tony Abbott was making about the price of electricity prompted us to be more price-conscious and look for ways to reduce our usage.

The network operators began investing heavily to improve the capacity of the network to meet the ever-higher peak demand for power on hot summer afternoons when a growing number of us had airconditioners going full blast.

One small problem: the fall in annual demand for electricity meant the brief seasonal peak had stopped rising. For several years the industry refused to believe the downturn in demand from the network was more than a blip.

So we've expanded the capacity of the network beyond what we're likely to need for some time. But you and I are paying extra for this expansion and will continue paying until it's paid off.

The good news is the econocrats have finally woken up to the problem. Actually, they were woken up in 2012 by the fuss Julia Gillard made when she realised Abbott was framing her for price rises she didn't cause.

In 2012 the rules were changed to give the regulators greater power to limit increases in the network charges passed on to retailers. Such changes take far longer than you'd imagine to flow through, but from now on it seems likely the network component of retail electricity bills will stay fairly steady in dollar terms.

The econocrats have proposed a further reform which, when it takes effect, will require the networks to bill retailers according to the time of day and time of year when you and I use electricity. With the spread of "smart meters" - which show the precise times when each household uses its electricity - we'll be charged according to our time of use, with those of us who show restraint during peak periods paying less, and those who don't paying more. This should produce a lasting solution to the (expensive) problem of ever-rising peak demand on hot afternoons.

That leaves the question of the effectiveness of competition between the growing number of electricity retailers, big and small. Here the jury is still out. Much depends on how smart we are in finding the retailer offering the best deal - on which quest I offer some tips in my little online video spiel.

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How the econocrats can lift their game

When we judge the performance of chief executives, most of us know the boss who's good at cutting costs isn't worth as much as the boss who's also able to improve the outfit's products and processes. Well, the same goes for treasurers and finance ministers - and their econocrats.

It seems the fiscal managers are running low on good ideas. But not to worry - the former Treasury and prime ministerial adviser Dr Ric Simes, now of Deloitte Access Economics, had some useful advice to offer in a speech to the Australian Business Economists last week.

Simes argues governments themselves have an important role to play in achieving the improved productivity performance the econocrats keep saying we need. Especially when "productivity" is better thought of as "technological progress" and the figures for measured productivity aren't as important as actual improvements in welfare.

"For those parts of the economy where market forces are paramount, government's main role is to make sure that regulation or its own actions allow competition to unfold without unwarranted intervention," Simes says.

To me, this means econocrats should urge their masters to tread carefully when powerful business interests, fighting to shore up a technologically superseded business model, demand that governments make breaches of government-granted copyright a hanging offence.

As Simes says, digital technologies have lower entry barriers and are forcing businesses to be both more productive and more responsive to consumers. So don't help incumbents resist change.

But, he says, the potential for technology to make some of the largest improvements in Australian lives lies in government-heavy sectors including health, education and transport. In these areas, progress has been too gradual.

"The exemplar is probably electronic health records, which have been the focus of considerable effort for perhaps 15 years now, but where we still seem to be a long way off the goal of having them routinely used throughout the health system.

"Or, take even an example where we have done well, the SCATS - Sydney Co-ordinated Adaptive Traffic System - for control of traffic lights. SCATS was originally developed 40 years ago, it has been constantly refined since then and is now in use in 27 countries.

"So, a success story - yet, as a Sydney driver, I know my welfare would be improved with a more refined SCATS system. It's coming - NICTA [the National Information Communications Technology Research Centre of Excellence] and others are working on optical-based monitoring and improved optimisation algorithms - but more support for both the research and especially its deployment would lift my welfare!"

Simes notes that in both cases, electronic health records and SCATS, the strict efficiency improvements from the technology - the bit that would help government budgets - represent a relatively small part of the overall benefits to the community.

"Especially in health and education, many of the benefits will involve improvements in the quality and range of services rather than efficiency gains," he says.

"Making the most effective use of digital technologies in health and education - as well as other areas where government has a direct role, such as smart technologies in transport and utilities - will deliver much larger economic and social benefits than where we seem to like to focus much of our policy attention, such as whether we should get the budget back into balance by 2017 or 2019."

Another potentially major area of micro-economic reform, Simes says, is how we organise our cities. Up to 80 per cent of Australia's output and employment occurs within its major cities. This has happened in the pursuit of economies of agglomeration.

"Yet we know that the problems are mounting. Congestion, compromised open spaces, the loss of amenity all risk detracting more and more from those benefits."

As with digital, many of the benefits from fixing these problems would not show up in our standard measures of welfare derived from the national accounts.

"Ten minutes less travelling time to work, or to school, doesn't have direct effects on gross domestic product. A more vibrant space around the harbour, or convenient shopping centre in the 'burbs, doesn't get picked up. But social welfare is clearly affected," he says.

Taking Sydney as an example, if commuter travel times on its roads were reduced by five minutes per trip, the benefits would amount to $3.6 billion a year, if an individual's time is valued at average weekly earnings.

To this you could add savings for freight or commercial vehicles. And savings for going to the shops, or school, or to the beach.

Echoing the patron saint of treasurers, Simes wants to lift our gaze to "the big picture".

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Digital revolution transforms productivity debate

A second former econocrat has joined former secretary of the Prime Minister's department Dr Mike Keating in seeking to lift the tone of the economic debate.

"We are spending too much effort debating how and how quickly we should bring the Commonwealth budget back into balance," Dr Ric Simes said in a speech to the Australian Business Economists this week.

"We need to elevate the economic debate from the level of catchcries about debt and deficits, or about productivity or even about the use of cost-benefit analyses. We need some deeper analyses being brought to the surface."

Simes, now a director of Deloitte Access Economics, formerly of Treasury and economic adviser to Paul Keating as prime minister, wants to see a more sensible discussion about productivity.
Productivity is obviously important and policy should indeed be focused on lifting it.

"But we do need to be careful about what this may mean in a particular circumstance," he said. One problem is that productivity is being used as a catchcry for myriad causes, often unjustifiably.

Simes agreed with Mike Keating's trenchant observation that "business associations, some leading employers and their camp followers in the media are insisting that future reforms must focus on alleged labour market rigidities and reductions in taxation, as if these were the most important influences on productivity".

And while "there is scope for improved labour relations to make a modest contribution to improved productivity ... the main responsibility for improvements in that regard lie with employers themselves," Keating has written.

"The best thing that employers and their trade associations could do is to stop passing the buck to everyone else for their own failings, and get on with making their workplaces more productive using the existing freedoms that they undoubtedly have," Keating concludes.

Simes adds that this is exactly what most businesses try to do. For his evidence, keep reading.

Simes' second problem with how "productivity" is being used in the debate concerns its measurement. "Productivity is simply a less than perfect measure of economic wellbeing, and having the public debate focus so much on what the Bureau of Statistics reports as productivity can be unhelpful."

Indeed, Professor John Quiggin, of the University of Queensland, had called productivity an "unhelpful concept", mainly because of problems with the way the contributions of labour and capital were measured in its calculation.

Simes agreed with Quiggin that we'd be better off using a term that was closely related to productivity, "technological progress" - that is, the introduction of technological innovations such as new products and improved production technologies.

Rhetoric - the choice of terms - did matter, Simes said, and had we been using the term technological progress instead of productivity, the debate wouldn't have been so open to distortion by vested interests.

"Tax, or industrial relations, or fiscal policy, can and should be refined, but they are not at the heart of why measured productivity weakened after 2000," he said.

But the measurement problem went further. "I think we have a fundamental problem in that our measures of gross domestic product or productivity are becoming less reliable proxies for economic welfare."

If instead of looking at productivity statistics we stand back and look at the way societies and businesses are changing, we find some profound changes under way, particularly the digital revolution.

We see consumers forcing retailers and media companies to transform. His own research had found that, without telework, only 14 per cent of new mums said they would return to work with their old employer, but 61 per cent said they would if telework was available.

His research had found how companies' information technology policies on staff use of social media at work and BYOD - bring your own device - were of growing importance in attracting young and talented employees.

He'd found that businesses able to create a "collaborative" working culture - including through use of digital technologies - succeeded in growing faster than otherwise.

What has this to do with productivity? First, most of the change we were seeing was being driven by individuals, whether they be consumers, workers, students or patients. To a trained economist, this should suggest that economic welfare had probably risen - and risen a lot.

It was hard not to conclude that individuals making deliberate decisions to do something new were adding to their own welfare, and to society's.

But, second, if this isn't showing up in our measures of welfare - such as GDP or productivity - then maybe there was something wrong with those measures. It seemed to Simes that "productivity, as measured, misses many, if not most, of the gains to consumer and social welfare that digital technology is delivering".

It didn't capture the benefits from improved convenience when we no longer had to queue for ages to renew a licence or at our bank branch. Nor the convenience of being able to search for a needed service in a fraction of the time it took before the internet.

It didn't capture the benefits of much greater choice. The Amazon books site, for instance, took costs out of the supply chain (thus reducing prices to consumers) but also provided much greater choice of books in a convenient manner.

Studies by Erik Brynjolfsson and others at the Massachusetts Institute of Technology had estimated that the easy access to a greater choice of books generated seven to 10 times the consumer welfare that the more efficient supply chain generated (the only bit that would make it into measured productivity).

He wasn't saying we should include the benefits of convenience and choice in our measurement of GDP - that wouldn't work.

No. "What I am arguing is that we need to be careful to base policy decisions on a deeper understanding of our objectives and not be driven by simplistic rhetoric," he said.

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Why almost all of us are 'out of touch'

When politicians say things such as that the poor don't buy petrol, it's easy to accuse them of being "out of touch". Actually, all politicians face that accusation before they're through. It's one of our favourite things to say about pollies we disapprove of.

But let's turn it around: exactly how in touch are you and I? Much less than we imagine.

We know a lot about our own circumstances and those of our friends and neighbours, but are surprisingly deficient in our understanding of people outside our circle.

And one of our greatest deficiencies is our inability to see ourselves as others see us, to place ourselves on the spectrum. Take the question of income.

In 1999, researchers at the University of NSW conducted a survey asking people to nominate their family's gross income and then to say where they believed that income placed them in the distribution of all families' income.

The results showed that more than 93 per cent of respondents believed their income to be in the middle 60 per cent of the distribution.

Most of us like to imagine we're middle-income earners. Ask us where we fit and almost no one admits to being either rich or poor (unless they're accused of not using much petrol).

A survey conducted this year for the Australia Institute, found a similar result but put it a different way: nearly all Australians think the average income is the same as their own income.

Of those respondents reporting their own annual household income to be between $20,000 and $40,000, 58 per cent believed the average income of all households lay within that range.

For those on $40,000 to $60,000, 71 per cent thought this was average. For $60,000 to $80,000 it was 61 per cent, for $80,000 to $100,000 it was 55 per cent, and for $100,000 to $150,000 it was 51 per cent.

Even for those on more than $150,000 a year, a third of them thought that was average. According to the Australian Bureau of Statistics, the average household income in Australia is $80,700.

But how could so many of us be so out of touch? How could we be so unaware of how the other half lives and which half we fit into?

I'm sure there are various reasons, but one of the big ones is something that's been going on for years without most of us noticing. Our cities are becoming more socially stratified, with the better-off congregating down one end and the less well-off down the other.

These days, you're less and less likely to find suburbs with a cross-section of high and low income-earners, or highly and lowly educated people.

So we don't know how the other half lives because they are in the other half - the half we live far away from and rarely visit or even drive past. Pretty much all our family, friends and workmates are in the same half we're in.

A study conducted last year by Jane-Frances Kelly and Peter Mares, of the Grattan Institute, Productive Cities, looked at maps of who lives where in Australia's largest cities and tracked how this had changed in the 20 years between 1991 and 2011.

The authors found that the residents of our four biggest cities have enjoyed rising incomes and have become much better qualified. At the same time, however, our cities had become more polarised.

"Increasingly, high-income residents with university-level qualifications cluster in suburbs close to city centres, while residents on lower incomes, and residents with vocational [trade certificate and diploma] qualifications, are more likely to live around the city fringes," they say.

"In each city, it is also possible to identify particular areas of disadvantage, where a high proportion of residents have no formal qualifications beyond secondary school, where labour market participation is low and where a high proportion of young people are 'disconnected' - that is, neither working nor engaged in education or training."

In Sydney and Melbourne, individuals on higher incomes are clustered in inner suburbs and suburbs with desirable natural attributes such as beaches, trees and hills.

In Sydney, the highest median incomes are found in inner, northern and harbourside and beachside suburbs, while the lowest median incomes are concentrated in western and south-western suburbs more distant from the CBD.

In Melbourne, the highest median incomes are found in inner, eastern and bayside suburbs, while the lowest median incomes are concentrated in more distant western, northern and south-eastern suburbs.

A map also shows a clear pattern in house prices. "The premium placed on proximity to the city centre is evident in steep house-price gradients in Sydney, Melbourne, Brisbane and Perth," they say.

Research by the Reserve Bank shows that, if you rank house prices for any of those cities according to their distance from the central business district, you get an almost perfect curve that (using figures from 2010) starts well above $1 million in Melbourne and Sydney and then declines steadily to about $300,000 when you're more than 60 kilometres from the centre.

This relationship between proximity and house prices has strengthened in recent decades, with average annual growth in house prices about 2 per cent higher in inner suburbs within five kilometres of the centre than on city fringes.

Those people out in the boondocks have no idea how much we struggle with our mortgages - and we have no idea that they have problems too. Price of petrol, for starters.

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Mining boom makes little sense

Conventional economic analysis assumes the behaviour of businesses is always rational but, in reality, the booms and busts that cause the ups and downs of the business cycle are driven by emotion more than rational calculation: unwarranted optimism, greed, impatience, short-sightedness and herd behaviour. Consider our resources boom.

The ideology of economic rationalism says private enterprise can do no wrong; ill-advised behaviour by business arises only through its rational response to distorted incentives created by the misguided interventions of governments.

This confers on the demands made by business a sanctity the captains of industry are quick to exploit. But their demands often aren't in the community's wider interest.

Now we're emerging from the decade-long resources boom it's easier to view the process with greater insight and make a more sober assessment of its costs and benefits.

What happened was a huge jump in the world prices of coal and iron ore as China's period of rapid economic development of heavy industry and infrastructure caused global demand to outstrip global supply.

The surge in China's demand caught the world's mining industry unprepared.

Like miners in other countries, our largely foreign-owned miners lapped up the huge increase in prices and profits.

But it didn't take long for greed ("the profit motive", if you prefer) and the irrational optimism that drives the world's entrepreneurs to take over, with companies seeking to exploit the high prices to the full by expanding their production capacity as much as possible as fast as possible.

What then kicked off was a multibillion-dollar race - between rival companies in a country, but also with the many companies in other countries, all expanding their capacity as fast as they could.

It takes a long time to build new mines and bring them into production. So the chances of your mine being completed in time to enjoy the super-high prices aren't great - the more so because it's essentially a self-defeating process: the more companies join the race and the harder they try to be among the first to complete, the sooner supply catches up with demand and prices start falling.

If mining companies were more rational, fewer would join the race. But companies are just as subject to herd behaviour as investors in a booming sharemarket. A mining chief who didn't join the comp would be subject to heavy criticism.

This is where the irrational optimism comes in. Each individual entrepreneur is in no doubt he'll be among the race's winners. We're gonna make a motza.

But while the miners are busy gearing up, their foreign customers are just as likely to be coming towards the end of their own boom in investment and construction. The inevitable result is that the global mining industry moves from a starting point of undercapacity to an end point of overcapacity.

This is the eternal story of mining. Only in passing is it ever in equilibrium; it's almost always in either under or oversupply - probably spending a lot more time over than under, the less profitable of the two conditions.

Now, this cycle isn't news to conventional economics, with its familiar "cobweb theorem" and "hog cycle" seeking to explain the phenomenon. But these models put too much of the blame on the unavoidable delays in increasing production, and too little on animal spirits.

And they don't prepare us for all the waste and inefficiency involved in a resources boom. In the miners' race to be first in and best dressed they compete furiously for resources, bidding up hugely the prices of labour, equipment and materials, and ending up with mines that cost them far too much to build.

They also develop lower-grade mineral deposits, the exploitation of which becomes uneconomic as soon as the world price drops back from its record heights.

In the aftermath of the boom, many acquisitions are written off, the chief executives who presided over these excesses get the chop and are replaced by bosses whose main skill is cost-cutting. They make speeches about how excessive Australian wages are.

Anyone who has followed the fortunes of our big three - BHP Billiton, Rio Tinto and Glencore Xstrata - will know just what I'm talking about.

In their race-driven frenzy to start new projects, the miners always portray themselves as impatient for God's will to prevail, with any politicians or community members who have doubts about allowing them to rip up the environment denounced as agents of the anti-progress devil.

In the aftermath of such booms we realise we should have refused to be rushed. Why does no economist ever warn us to be less short-sighted? Their faulty model.

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Many reasons for the impossible: power demand falling

We know the two great certainties in life are death and taxes, but many thought there was a third: the inexorable rise in consumption of electricity. As the population grew and each of us got a little more prosperous each year, we'd use more power. The mighty electricity industry was built on that certainty.

Except that electricity consumption has been falling for the past four years. To say this has taken the industry by surprise is an understatement. For well over a century – even during the Great Depression – the quantity of electricity used in Australia each year was greater than the year before.

It took the industry and its regulators two or three years to accept the trend was more than just a hiccup on the ever-upward path, which delay probably added to the decline.

There are few aspects of the economy – global or national – where change is more significant, more diverse or more interesting than energy supply and demand – where energy covers coal, gas (conventional and unconventional), petroleum, wind, solar and other renewables. Expect to hear more from me on the topic.

But there are few questions more interesting than exactly why the unthinkable, a fall in electricity consumption, has come about. Short answer: a surprisingly large combination of reasons, although Tony Abbott's crusading against the carbon tax must get some of the credit.

The best attempt to quantify the various factors involved comes from a report prepared by Dr Hugh Saddler, an energy expert with the Pitt and Sherry consultancy, for the Australia Institute. Saddler's modelling covers the years to 2012-13, but we know from reporting this week by Origin Energy and AGL that the fall continued in 2013-14.

Saddler focuses on energy produced and consumed from the National Energy Market, which covers the five eastern states and the ACT, but the decline is occurring also in Western Australia. After peaking in 2008-09, consumption from the national market in 2012-13 was down by almost 8 terawatt hours, or 4.3 per cent.

But that's only half the story. Just as important as why demand has fallen is why it hasn't continued growing, as continued growth in the population and the economy would lead us to expect. Saddler estimates that had demand continued growing from 2004 at its average rate of growth over the previous 20 years (2.5 per cent a year) it would have been 37 terawatt hours more than it actually was in 2012-13.

This shortfall is equal to the output of almost 5000 megawatts of coal-fired generation capacity, the combined capacity of the Bayswater and Eraring power stations in NSW, or Loy Yang A and B and Hazelwood in Victoria.

"All of the decline in consumption has been at the expense of coal-fired generators, with the result that many are now barely profitable," Saddler says.

Greenhouse gas emissions fell by 9.2 megatonnes of carbon dioxide equivalent, about 2 per cent of Australians total annual emissions.

So what has caused our power consumption to fall rather than rise? The biggest single reason is the introduction from the late 1990s of regulations to increase the energy efficiency of refrigerators, freezers and many other residential and commercial appliances, and to increase the energy efficiency of new buildings.

Saddler estimates this explains 37 per cent of the 37 terawatt-hour shortfall from what might have been.

The next biggest part of the explanation is structural change in the economy away from electricity-intensive industries. Over the year to September 2012, three major NSW industrial power users – Port Kembla steelworks, Kurri Kurri aluminium smelter and the Clyde oil refinery – were partly or completely shut down. This explains 10 per cent of the 37 terawatt-hour shortfall.

The evidence also suggests that power consumption by other major industrial users has been little changed over the three years to 2012-13. Saddler estimates that this failure to grow explains a further 14 per cent of the shortfall, taking the total contribution from structural change to almost a quarter.

The next most important part of the explanation is the response of electricity users, particularly residential users, to the higher prices they were being charged. Saddler finds that after 2010 there was "an abrupt change in consumer responsiveness to higher prices".

This was the time when the possible effect of a carbon tax on electricity became a major political issue thanks to the efforts of Abbott and his "sceptic" mates. At the time, retail electricity prices were rising spectacularly, mainly because of a huge increase in spending on upgrading the transmission and distribution networks (poles and wires) to cope with an expected ever-rising peak demand on hot summer afternoons.

Saddler finds evidence to support his argument that all this carbon-tax-related fuss about the high cost of electricity caused many households to be a lot more conscious of what was happening to their power bills and to respond by finding ways to cut their usage – to the extent that they "have managed to completely offset the effect of higher prices on their household budgets by reducing consumption".

This highly unusual jump in the short-run "price elasticity" of electricity explains 19 per cent of the shortfall, he estimates.

He further calculates that the growth in output from rooftop photovoltaic solar and other small, distributed generators accounts for about 13 per cent of the shortfall. This, of course, is a fall in the demand for electricity supplied by the major, mainly coal-fired generators, not a fall in the use of electricity as such.

Saddler notes that for the past three years the annual peak demand has been falling, not increasing, despite the huge investment to cope with ever-rising peaks. When will this additional capacity, which is now built and for which all electricity consumers are paying – and will continue to pay for some years to come – be required, if ever, he asks.

Good question.

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