Let's be more hard-nosed towards foreign miners

Joe Hockey and Competition and Consumer Commission boss Rod Sims must surely deserve a medal for their selfless devotion to the interests of foreigners, after their shocked reaction to Twiggy Forrest's suggestion that the world's big producers stop the plunge in iron ore prices by limiting their output.

And here was me thinking economics was about rational self-interest.

Hockey sniffed that the idea smacked of forming a cartel. Which was good of him when you remember the way the plunging price of iron ore is robbing his budget of company tax revenue and causing his deficits to be bigger than those Labor left.

We can't afford to give much money to the foreign poor, but if foreign-owned mining companies want to keep forcing down ore prices by expanding production at a time when world demand is weak, that's fine by Joe.

Sims proclaims that cartels are illegal and is investigating whether Twiggy should be prosecuted. It surely can't have escaped his notice that very little of Australia's iron ore production is used locally, meaning no Australian consumers or businesses would suffer from such an arrangement.

But that, apparently, is not the point. Cartels are morally wrong, even if they advance Australia's national interest. If big foreign-owned producers such as Rio Tinto and BHP Billiton want to use their lower costs per unit to keep expanding production, forcing down the world price and attempting to wipe out higher-cost Australian-owned producers such as Forrest's Fortescue Metals, good luck to them.

Fine by us. That's the way the global resources game has always been played – wild swings from excess demand and inadequate supply causing booms, to weak demand and excess supply causing busts – and so that's the way it must continue to be played.

No effort can or should be made to moderate this crazy game. That there is a lot of fallout on bystanding industries, workers and consumers in the countries where big mining chooses to play this contact sport, is just an unfortunate fact of economic life which it is our government's sacred duty to make us grin and bear.

But while we're being so noble and self-sacrificing, it's worth remembering it wasn't always thus. Consider the many decades in which our governments sought to stabilise the world price of wool, which ended badly only after misguided economic rationalists handed control of the scheme to the woolgrowers themselves.

And don't forget the old Australian Wheat Board's "single desk". We weren't big enough to control world wheat prices, but we did make sure our growers weren't bidding against each other.

While the punters talk xenophobic nonsense about Chinese state-owned corporations taking over NSW's electricity poles and wires, Australia's economists have a deeply ingrained ethic that it's a form of racism ever to acknowledge that a company is foreign-owned.

Now we're in the final throes of the decade-long mining resources boom, it's a good time to reflect on how much we got out of it (not all that much, remembering it's all our minerals) and how well we handled it.

We played it by letting the foreign mining companies do pretty much whatever they wanted, which was to build as many new mines and gas facilities as possible in minimum time. This insane rush came at the expense of all our other industries, but no one questioned its wisdom.

It was left to the Reserve Bank to ensure the miners' greedy stampede didn't cause a wages breakout and inflation surge, which it did by repressing the rest of the economy. To "make room" for the money-crazed miners, it held interest rates higher than they otherwise would have been, which may have caused the exchange rate to be even higher than otherwise.

Was any effort made to assess whether attempting to build 180 resource projects in three years was in the national interest? Yes, but the economists left it to the lawyers. Each of those projects would have been accompanied by an environmental assessment assuring some court that the project would create thousands of jobs and do wonders for the economy.

Evaluating each project separately, the lawyers bought it. You needed to be a macro-economist to see that, added together, those claims made no sense. There wasn't that much skilled labour available and, with the economy near full employment, it just isn't possible to create many extra jobs. All you'd do is move jobs around, bidding up wages and creating shortages in the process.

But the macro-economists were away at the time, probably busy explaining to politicians why it was our economic duty to allow foreign mining companies to use our economy as a doormat.

Read more >>

State governments don't greatly affect the economy

With the election over, Sunday is the first day of the rest of the life of the NSW economy under the new Baird government. So how much has changed?

A lot less than the rhetoric of the election campaign may have led you to expect.

State elections are times when governments claim the credit for all the good things happening in the economy and get blamed by oppositions for all the bad things.

In truth, they should get only some of the credit or blame. That's because there is really no such animal as the NSW economy.

There are no barriers between NSW and the other states and territories, meaning it's just the NSW corner of the national economy.

So the government agencies with the most influence over our corner are the Reserve Bank and the federal government.

It is true the NSW economy has grown relatively strongly since the O'Farrell-Baird government took over four years ago. We were performing poorly compared with other states, but now we are doing best in various categories.

But that's mainly because market economies are cyclical: what goes up must come down, and what is down will go back up soon enough.

What came down was Western Australia and Queensland as the mining construction boom came to an end. What went back up was NSW and Victoria as things got back to normal.

Because NSW is by far the largest of the states, it is rarely far from the national average, and often a bit above it.

But the Coalition's economic policies have been good and it can take some of the credit for our improved performance.

Historically, NSW has had trouble building enough new housing to accommodate the state's growing population, a problem that does much to explain Sydney's exceptionally high house prices – and one the state government can do much to improve.

The undue regulation and high charges on developers have limited the supply of new homes on the outskirts of the city, and planning restrictions have permitted too little of the medium and high-density in-fill home buyers are demanding so as to be closer to jobs.

But a lot more homes are now being built, for which Mike Baird should get credit. This higher level of building is likely to continue.

State governments have no control over immigration and national population growth, but are responsible for solving the growing social and economic problem of traffic congestion and long commute times.

Both sides of politics have neglected the development of public transport. And road projects such as WestConnex are likely to offer only temporary relief.

The state's performance on employment has improved relative to the other states, but worsened with the national performance in recent years.

It will continue slowly worsening until the national economy picks up speed. Schemes offering payroll tax incentives to encourage businesses to increase employment are gimmicks to impress voters at election times.

Read more >>

A rational analysis of Hockey's 'asset recycling'

I'm never sure who annoy me more, the business types who are certain every business is better run if privately owned, or the lefties who oppose every sale of government-owned businesses on principle.

On the question of privatisation, mindless prejudice is no substitute for rational analysis of the pros and cons. On the tricky question of the "asset recycling" being promoted by Joe Hockey to all state governments with businesses left to sell, careful analysis is essential.

Premier Mike Baird's hugely controversial proposal to sell most of NSW's electricity transmission and distribution network businesses – the "poles and wires" – and use the proceeds to finance $20 billion worth of public transport, road and other infrastructure is a classic example of asset recycling.

It offers a good case study in thinking through the issues, even to people who won't be voting in Saturday's state election.

You must cover all the relevant major considerations for and against, ignoring considerations that aren't relevant (or are common to both alternatives). You have to remember to take account of opportunity costs as well as actual costs and to avoid any double counting.

It will avoid confusion if we consider the two sides of the proposition separately. First, is it a good idea to sell the poles-and-wires businesses to private owners? Second, assuming the planned infrastructure projects are worthwhile, is privatising businesses the only way available to finance them?

The obvious starting point for consumers is: would selling the businesses lead to electricity prices being higher than they would be under continued public ownership? Or would there be a decline in the quality of service, such as blackouts?

In this particular case, the answers are more certain than usual: no and no. That's because, the networks being natural monopolies, the prices they charge are controlled by the Australian Energy Regulator, which believes they're already too high. Service quality is also tightly regulated.

The regulator's determination to get efficiency up and prices down suggests there will be job losses – in other states as well as NSW – whether or not the businesses are privatised.

This being so, the main issues of contention concern state government finances. The critics of privatisation stress that it's no magic pudding: sell these profitable businesses and you lose the dividends they were paying the government, along with the equivalent of the company tax they were paying to the state (because state-owned businesses don't pay tax to the federal government).

That's obviously true. But remember that, according to economic theory, the sale price of any business should be the "present value" of the stream of income it's expected to earn in coming years.

If so, the seller is perfectly compensated in the sale price for the loss of future dividends. Why else would they sell?

But does the theory work in practice? Not perfectly. For one thing, who can be sure what income will be earned in the future? The seller ought to have a better idea than the buyer, but if there aren't many potential buyers and the seller is anxious to sell, they may settle for less than they should.

Alternatively, if there are a lot of potential buyers, the seller may get more than the business is worth. Almost all buyers of established businesses are confident they can run it more profitably than the present owner.

Point is, provided the sale price is adequate, there's no financial reason to regret the loss of dividends. A complication is that a fair price would not compensate the state government for its loss of tax equivalent payments.

That's because a new private owner would be liable to pay real company tax to the federal government. This is part of the rationale for Hockey's scheme to give federal grants – $2 billion, in this case – to states that take part in his asset-recycling incentive scheme.

A factor having a bigger (downward) influence on the amount of the fair sale price is that the flow of annual profits from the network business in coming years is likely to be much lower than the recent $1.7 billion a year that Labor's Luke Foley keeps quoting.

That's partly because the regulator has signalled its intention to crack down on the excessive profits being earned by the nation's electricity network businesses, but also because the demand for electricity from the grid is falling and will fall further as people move to solar and the introduction of smart meters helps homes and businesses limit their demand for power.

(This demonstrates the economic truth that natural monopolies are a product of the existing technology. The network businesses' monopoly is being eroded by climate-change-driven technological advance.)

Some critics argue that selling profit-making assets and replacing them with roads and loss-making public transport reduces the state government's "net worth" and weakens its balance sheet.

This is true arithmetically, but is a strange argument. Governments aren't profit-seeking businesses. Their job is to meet the social and economic needs of their community by, among other things, ensuring the provision of adequate infrastructure – directly profitable or otherwise.

Turning to the predicated link between the sale of network businesses and the spending on needed infrastructure, it rests on an assumption it would be unthinkable for the state government to lose its AAA credit rating, which would happen if it simply borrowed another $20 billion.

For decades, federal and state treasuries have used credit ratings to beat off unworthy proposals for vote-buying capital works. But I think we have little to lose by causing the discredited rating agencies to lower our rating by a notch or two.

But though their limit on our debt level may be too low, there does have to be some safe limit. And the doctrine that state governments may acquire assets but, once acquired, they may never ever be sold off, strikes me as weird.

Read more >>

Poles and wires: who's misleading us about what

The politicians' decades of bad behaviour may have caused them to lose our trust, but not our mistrust - making us suckers for scare campaigns.

This election campaign has been dominated not by reasoned debate but by Labor and the power unions' almighty scare campaign over the sale of the state's electricity poles and wires.

It's the most successful scare-job since all the dishonest things Tony Abbott said about how the carbon tax would destroy the economy.

The truth is it doesn't matter much to electricity users whether the state's power transmission and distribution businesses stay government-owned or are sold off. That's because, being natural monopolies, the prices they charge are controlled by a national body, the Australian Energy Regulator.

The standard of service they deliver - blackouts, for instance - is also tightly regulated.

It is true that private owners would attempt to increase their profits by reducing overstaffing and other inefficiencies - which tells you what the power unions are so excited about - but the regulator has announced its intention to force all the nation's public and privately owned poles and wires businesses to raise their efficiency and to ensure the savings are passed on to consumers as lower prices.

It's clear that, whoever owns the poles and wires, those businesses will be doing it much tougher in coming years. That's because the demand for electricity from their grid will keep falling, with households and businesses moving to solar and the introduction of smart meters helping households cut their usage, especially at peak periods.

This is why the dividends the state government would lose by selling the businesses would be a lot lower than the present $1.7 billion a year Luke Foley keeps claiming. (A characteristic of scare campaigns is that you stick to your wrong claims even after you've been caught out.)

This is not to say we can believe everything Mike Baird has been saying, of course. He describes his plan as "the long-term lease of 49 per cent of the NSW electricity network". This is highly misleading, an attempt to fool us into believing he isn't really privatising the network.

There's little practical difference between a 99-year lease and an outright sale. And that figure of 49 per cent - making it seem the government would retain majority ownership of the network - is highly contrived.

Baird plans to sell 100 per cent of TransGrid, the state-wide high-voltage transmission business, and 50.4 per cent each of Ausgrid and Endeavour Energy - which distribute power locally to about 70 per cent of the state's population living between Ulladulla and Newcastle, and inland to Scone, Lithgow and Bowral.

How does that add up just 49 per cent? By taking account of the plan not  to sell any of Essential Energy, which distributes power to the state's backblocks. Convinced?

A separate question is: is selling the electricity network the only way we would be able to fund the $20 billion in new public transport, road and other infrastructure Baird promises?

Yes - if you think it matters that the state keeps its triple-A credit rating. No - if you don't. I don't.

Read more >>

Should taxpayers develop properties for churches?

Election campaigns are busy times for interest groups. They turn up the pressure on governments and oppositions to give them written promises to grant them particular benefits, or not do things the groups don't fancy, during the next term.

It's surprising how often the pollies give in to such tactics. They do so for fear the interest groups will campaign against them if they don't sign on the line.

In the last federal election, for instance, the banks and other financial institutions got the Labor government to promise not to make any more adverse changes to the taxation of superannuation for five years, then persuaded the Coalition to match Labor's promise during its first term. A lot of promises have been broken since then, but not this one.

Historically, few groups have pursued this tactic more successfully than the Catholic systemic schools. If you were a pollie, which would you choose: risk being preached against on the Sunday before election day, or be photographed beside a beaming archbishop as you sign the deal?

Recognising the Catholics' superior bargaining power, the other religious and independent schools tend to ride on their coat-tails.

Late last month the Catholic Education Commission announced that in the NSW election campaign it would "play an advocacy role in the interests of students, parents and teachers in the Catholic education sector".

Its "key policy issue" is that, in the light of the expected growth in the number of schoolchildren, the state government "must increase its capital funding to Catholic schools to help Catholic schools enrol their share of this growth".

Last year, we're told, the state's 584 Catholic schools educated 21 per cent of the state's students, but received only 2 per cent of the NSW government's capital funding for schools.

"The NSW Government must first reverse its 2012 decision to cap capital funding to non-government schools at $11 million per year and put in place a sustainable, long-term funding framework that grows as enrolments increase", the commission's executive director, Brian Croke, said.

The Catholic schools' share of the $11 million was $7.6 million, equivalent to about $30 per student, while government schools received more than $399 million, or $524 per student.

The state government's forecast is that all NSW schools will need to accommodate an extra 267,000 students by 2031. For the proportion of students in Catholic schools to remain unchanged, Catholic schools would need to create places for a further 58,000 students, the equivalent of more than 2300 new classrooms.

Sorry, but this argument needs thinking about. For one thing, the campaigners don't mention that non-government schools also receive capital funding from the federal government, which is a lot more generous than state grants.

For another, it's hardly surprising the state government spends a lot more on building and equipping its own schools than it does on subsidising other people's schools.

Where do taxpayers' obligations to Catholic and other non-government schools end? Governments have an obligation to provide for a growing student population, but do they have an obligation to ensure Catholic or any other non-government group's share of the school population doesn't decline as the population grows?

For religious or other groups to say they have school facilities they wish to make available for the education of kids - kids of their own choosing in locations of their own choosing - is one thing. For those groups to argue governments have an obligation to subsidise their provision of additional facilities so their share of the overall school population doesn't drop is quite another.

Who's to say those non-government groups will want to build their additional facilities in those locations where the population growth occurs? If the groups want to build in areas other than those of fastest growth - which these days would include the inner city - are taxpayers obliged still to cough up subsidies while also building the new schools where they're actually needed?

And is it reasonable to demand that taxpayers provide big subsidies towards the building of new facilities that remain the property of the churches or other groups involved?

The Catholics argue that their building of new facilities has been, and will continue to be, largely funded by parents. So the church itself doesn't put up much, but gets to retain ownership of the schools while the parents move on. When it comes to real estate, I wouldn't have thought the mainstream churches were all that property poor.

Federal grants come with a proviso that, should the subsidised school facilities be sold or used for another purpose within the first 20 years, the government may ask for its grants to be repaid. How often this provision is enforced I don't know.

We've long been asked to believe the non-government schools are doing taxpayers a favour, providing education to kids that taxpayers would otherwise have to pay for. But this demand for capital grants is aimed at reducing the size of the favour.

And when it comes to recurrent funding, the favour isn't all that great. Federal and state grants covered almost three-quarters of the costs of running Catholic schools in 2012. Fees charged to parents covered another 22 per cent.

With the election just a few days away, I'm hoping whichever side wins will get through without promising more funds to non-government schools. But we may not know whether they have until after it's over.

Read more >>

Budget needs more efficiency, less deficit repression

Joe Hockey's intergenerational report says something I really agree with: "to ensure government expenditure is sustainable and better targeted . . . governments need to focus their efforts on achieving the efficient provision of services".

At last, Hockey is acknowledging that we need to reduce the rate of growth in government spending in ways that increase the efficiency of the government's delivery of services.

To me – but no one else, it seems – the pet shop galahs' call for "more micro reform" points directly at two of our biggest industries, healthcare and education, which happen to be mainly in the public sector.

The intergenerational report projects that federal healthcare spending will rise only modestly over the next 40 years from 4.2 per cent of gross domestic product to 5.5 per cent, while federal education spending actually falls from 1.7 per cent to 1 per cent.

Believe that and you'll believe anything. These implausible projections rest on assumptions that the unsustainable cuts in the indexation of federal grants for state hospitals and schools plus the deregulation of uni fees proposed in last year's budget will roll on untouched for four decades.

Truth is, both healthcare and education are "superior goods", meaning they make up an ever growing proportion of consumption as real incomes rise over time. They account for such a large proportion of federal and state government spending that they expose the fiscal monoculists' goal of cutting spending to the point where taxation stops increasing and even falls, for the pipe dream it is.

Fiscal monoculists are those who take a one-eyed view of the budget. If it's in deficit, this can only be caused by excessive spending, never by inadequate taxation, even when the lack of revenue arises from choice-distorting sectional tax breaks, blatant multinational tax avoidance or irresponsible Reagan-style tax cuts.

Brushing aside the more obvious objections to last year's budget, another was its dearth of what Paul Keating called "quality cuts". These are cuts that aim to improve the efficiency of the provision of services.

By contrast, most of the savings came from nothing more virtuous than cost-shifting – to the young unemployed, university graduates, the aged, the sick and, above all, the state governments. This is why so many of the measures, even if they'd got through the Senate, were unsustainable.

You could argue that the GP co-payment, with its introduction of a price signal, and the deregulation of uni fees were genuine, cost-saving reforms, aimed at increasing efficiency in healthcare and higher education.

But such an argument stands up only if you make the most cursory examination of the economics involved. A co-payment price signal improves efficiency only if it deters unnecessary consultations, not if it deters low-income patients from reporting serious problems to their GP before they get worse. Too many of the latter and your "reform" becomes a false economy, storing up higher costs for later.

Deregulating uni fees and expecting market forces to prevent over-charging is a case of magical thinking when you remember the unis remain government-owned and highly regulated, are possessors of market power, and would be selling a service still heavily subsidised by taxpayers via HECS's income-contingent, real-interest-free loans.

There are ways to cut costs in healthcare and education – or, at least, slow their rate of growth – without reducing quality, but they require a lot more thought and effort than was put into last year's GP co-payment and uni fee deregulation proposals.

If you accept that governments ought to be assisting the victims of homelessness, domestic violence, people who can't possibly afford legal representation, dispossessed Indigenous people, the working poor and so forth, it's not efficient to make savings by cutting grants to charities, whose non-profit benevolence is a free good being offered to the taxpayer.

Echoing economists' strictures against "repressed inflation" in days past, the prominent American economist Lawrence Summers is warning against the prevalence of "repressed deficits", where governments engage in accounting tricks and false economies to hide the true costs and make budget deficits and debt look better than they really are.

Such as? Failing to properly maintain public assets, deferring the replacement of infrastructure beyond the end of its useful life, effectively paying higher interest rates to persuade private firms to hide government-initiated debt on their own balance sheets or, with similar effect, engaging in the sale and leaseback of government offices.

On the latter, the Howard government wasted millions of taxpayers' dollars doing that in its first budget. And now, I hear, Hockey is planning the same thing for the Treasury building. Not smart, Joe.

Read more >>

Why fiscal policy may be making a comeback

For four decades, fiscal policy has been the poor relation among the tools available for countries to use to stabilise demand as their economies move through the ups and downs of the business cycle. Monetary policy has been the preferred instrument. But this may be about to change.

Monetary policy refers to the central bank's manipulation of interest rates, whereas fiscal policy refers to the government's manipulation of taxation and government spending in the budget.

Of course, in those four decades fiscal policy hasn't been completely friendless. In times of recession, politicians have almost always resorted to budgetary stimulus, sometimes against the advice of their econocrats.

In the policy response to the global financial crisis in late 2008, aimed at preventing it turning into a worldwide depression to rival the depression of the 1930s, there was an instinctive resort to budget spending in addition to the sharp easing of monetary policy.

The fiscal response was partly because the North Atlantic economies needed to lend money to their banks, but also because demand needed bolstering at a time when households and businesses, conscious of their high levels of debt and the diminished value of their assets, were in no mood to spend no matter how low interest rates were.

Urged on by the International Monetary Fund, all the major economies engaged in huge fiscal stimulus at the same time. This succeeded in averting depression and getting their economies on a path to recovery.

But by then the North Atlantic economies had high levels of public debt, and the ideological opponents of fiscal activism fought back, persuading Britain and the rest of Europe to abandon fiscal stimulus and instead cut government spending and raise taxes, even while their economies were still very weak.

Unsurprisingly, the result was to prolong their recessions and force them to resort to ever more unorthodox ways of trying to stimulate their economies with monetary policy.

In this column last Saturday we saw Dr Philip Lowe, deputy governor of the Reserve Bank, accepting that monetary policy had become a lot less effective around the developed world, but arguing this would cease to be so after the major advanced economies had finally shaken off the Great Recession in about a decade's time.

But a leading American economist, Professor Lawrence Summers, of Harvard, a former US Treasury secretary, argues that monetary policy's reduced effectiveness could last for the next quarter of a century.

This is because he sees world interest rates staying very low for at least that period. In all the recessions since World War II, the US Federal Reserve has had to cut its official interest rate by an average of 4 percentage points to get the economy moving again.

If interest rates stay low, the Fed (and other central banks) won't have room to cut the official rate to the necessary extent before hitting the "zero lower bound". This will make economic managers more dependent on fiscal policy to provide stimulus.

Why does he expect interest rates to stay low for so long? Because, at base, interest rates are the price that brings the supply of saving into balance with the demand for funds for investment.

And, in the developed economies, Summers sees less investment occurring because of weak or falling population growth, because capital equipment gets ever cheaper and possibly because of slower technological advance.

On the other hand, he sees higher rates of saving because more of the growth in income will be captured by high-income earners, with their higher propensity to save.

So if the supply of saving increases while the demand for funds decreases, real interest rates will be very low, even after all the quantitative easing (money creation) is unwound. Continuing low inflation will keep nominal interest rates low.

Summers argues that, over the decades, the popularity of fiscal policy has fluctuated with economists' changing views about the size of the fiscal "multiplier" – the size of the increase in national income brought about by a discretionary increase in government spending.

The latest view, coming from the IMF, is that the fiscal multipliers are much higher than previously believed (particularly for spending on infrastructure, less so for tax cuts). This is mainly because the reduced effectiveness of monetary policy has caused a change in central banks' "policy reaction function".

Whereas in earlier times the central bank would have increased interest rates if it feared fiscal stimulus threatened to worsen inflation (thereby reducing the fiscal multiplier), these days the central bank would be less worried about inflation and pleased to see fiscal policy helping it get the economy growing at an acceptable pace.

But Summers has another point. Lasting low real interest rates not only make monetary policy less effective and fiscal policy more effective, they also mean that lower debt servicing costs allow governments to carry more public debt.

His oversimplified calculation is that if the interest rate on public borrowing halves from 2 per cent to 1 per cent, a government can now carry twice as much debt for the same interest bill.

Let's put this interesting discussion into an immediate, Australian context. We know from the latest national accounts that, at a time when the economy's growth is too weak to stop unemployment continuing to creep up, public sector spending is acting as a drag.

This isn't because of federal government cuts in recurrent spending, but because the states have allowed their annual capital works programs to fall back at a time when private construction activity is falling through the floor and yields (interest rates) on government bonds are the lowest in living memory.

If the Feds had any sense they'd be borrowing big for well-chosen infrastructure projects, thereby reducing the pressure on the Reserve Bank to keep cutting interest rates and risking a house price bubble. The Reserve would love a bit of help from fiscal policy.

Read more >>

Our kids need social skills, not just high marks

My father raised me to be contemptuous of fashion in all its forms, and I try not to be overawed by the rich and powerful. But, like my mum, there's one thing I am impressed by: brains.

My job brings me into regular contact with the econocrats at the top of the Reserve Bank, Treasury and other departments. Let me tell you, they're the brightest of the bright. I have to keep telling myself this as I struggle to keep up with them. All of them could hold down jobs as professors, or earn a lot more money in business.

These days, most have PhDs - though it's disturbing that, so far in his time as Prime Minister, Tony Abbott has relinquished the services of five economist department secretaries: Dr Martin Parkinson, Dr Don Russell, Blair Comley, Dr Ian Watt and now Dr Paul Grimes. Not sure we have that many brains to spare.

In recent years, however, I've realised that being super-bright ain't enough. To be really successful you also need "people skills". I've decided an extra unit of EQ - emotional intelligence - is worth a lot more than an extra unit of IQ. And if a genie appears from a bottle, that's what I'll ask for.

Most of our politicians have heard that the development of children's brains is hugely significant in influencing their success throughout the rest of their lives. Hence governments' increasing attention to early childhood education and care.

What people may not realise is that brain development doesn't matter just because of its effect on kids' intellect. As a new report from the Organisation for Economic Co-operation and Development, The Power of Social and Emotional Skills, makes clear, it matters also for children's social development.

We don't need telling about the importance of "cognitive" skills. These days, governments conduct periodic tests of children's literacy, numeracy and scientific literacy as they progress through the school system.

They make the results available directly to parents, but also put them on websites so the whole world can compare the academic performance of particular schools. Teachers object that good teaching involves a lot more than the three Rs and that the emphasis on competition via "metrics" encourages schools to "teach to the test" and spend much time drilling for coming tests.

The OECD's PISA exercise now compares our cognitive tests with those undertaken in other countries, so that every year or so we agonise because we've slipped back in the international comp on this cognitive measure or that.

The point of this latest report is to agree with the teachers: there is a lot more to the adequate development of our kids than just nurturing their IQs. It finds that children and adolescents need a balanced set of cognitive and social and emotional skills in order to succeed in modern life.

Cognitive skills - as measured by achievement tests and academic grades - have been show to influence the likelihood of individuals' success in education and the jobs market. They also predict broader outcomes such as our self-perceived health, social and political participation, and trust.

But social and emotional skills - such as perseverance, sociability and self-esteem - have been shown to influence numerous measures of social outcomes, including better health, improved subjective wellbeing (aka happiness) and reduced odds of antisocial behaviour.

If that doesn't impress you, try this: cognitive skills and social and emotional skills interact and cross-fertilise each other, empowering children to succeed both in school and out of school.

For instance, social and emotional skills may help children translate intentions into actions, and thereby improve their likelihood of graduating from university, sticking to healthy lifestyles and avoiding aggressive behaviours, the report says.

For children who are talented, motivated, goal-driven and collegial, and thus more likely to weather the storms of life, cognitive skills aren't enough. They need to be combined with social and emotional skills, which include conscientiousness and emotional stability.

The report stresses that "skills beget skills". They build on each other, and the earlier kids start acquiring them and the firmer their foundation the more skills are gained and the better the kids do in life.

You may say that children from "good" homes will acquire social skills from their parents without any fuss. That's fairly true and it's why, apart from making attendance at preschool universal, early intervention programs are best targeted at disadvantaged families, offering parents training and mentoring.

But though an early start is best, children's acquired skills remain malleable through adolescence. Programs aimed at older children emphasise teachers' professional development. Among adolescents, mentoring seems to work well, while hands-on experiences in the workplace can instil skills such as teamwork, self-efficacy (strong belief in your ability to reach goals) and motivation.

Improvements in social skills don't necessarily require major reforms or resources but can be incorporated into existing curricular and extracurricular activities, the report says. A lot of social and emotional skills can be gained from sport, arts clubs, student councils and voluntary work.

The report finds that recent developments allow us to measure social and emotional skills reliably within a particular culture and language. I reckon that as long as we retain our obsession with measuring and comparing academic performance we need to balance this with regular measurement of progress in acquiring social skills.

Surely our econocrats are bright enough to see that.

Read more >>

We're not taking productivity seriously

Given our obsession with materialism, productivity "isn't everything, but in the long run it is almost everything," as Paul Krugman famously said. If so, the intergenerational report's consideration of the topic is quite inadequate.

It's partial in both senses. It mentions most of the key factors that influence productivity improvement - defined as increased goods and services produced per hour worked - but doesn't do justice to many, including climate change.

That's partly because, though the report purports to be about the future of the economy, its real target is Treasury's eternal top priority, the future of the budget balance.

But it's also because the econocrats are leading us towards their preferred policy response to our alleged productivity problem and away from those responses their "priors" - preconceived beliefs about how the world works - cause them to disapprove of.

There are two broad approaches to government efforts to improve productivity: one which involves more intervention and spending and one which involves less intervention and little change in spending. Guess which one Treasury's priors lead it to favour?

For the past 200 hundred years, most of the world's productivity improvement has come from technological advance - people inventing better machines and thinking of better ways to do things.

But the other fish Treasury wants to fry prompt it to embrace an extreme view held by a few American economists that we've entered a period of much less rapid technological change.

When you consider all the disruption the digital revolution is unleashing on so many industries this is hard to believe.

In the era of the knowledge economy, you'd expect much long and earnest discussion about what governments should and shouldn't be doing to encourage acquisition of the "human capital" that comes from education and training.

Should we be cutting budgetary support for science and research and development? Is now the right time to be pushing university funding off the budget and on to students and universities' money-making schemes?

Why would a government that professes to believe in "equality of opportunity" welch on its professed support for the Gonski reforms to school funding? Why would it view Gonski as about private versus public rather than about lifting the future participation and productivity of kids at the bottom of the distribution?

Instead, the issue of human capital is airily dismissed with the line that "there is little evidence that slower productivity growth has been the result of inadequate investment in skills, education and innovation more broadly".

Maybe. But it's probably equally true there's little evidence it hasn't been. All you're really saying is that there's little evidence - because we've never been willing to run to the expense of adequately measuring such a vital ingredient in our future wellbeing.

The other key element of productivity improvement that gets short shrift is public infrastructure spending. To what extent are its inadequacies limiting the productivity of businesses and adding to commuting times (an important part of our wellbeing that doesn't show up in gross domestic product)? But do workers who spend an hour getting to work arrive at their productive best?

No discussion of our present and future productivity performance is adequate without assessment of the role being played by our policy of high immigration. But all we get is the throwaway line that "there is some evidence that" high levels of migration increase productivity because our focus on skilled migration raises the workforce's average skill level and because "migrants can be highly motivated".

This is true and quite dishonest at the same time. It minutely examines the dog in the room while studiously ignoring the elephant. What economists know but try not to think about - and never ever mention in front of the children - is that immigration carries a huge threat to our productivity.

The unthinkable truth is that unless we invest in enough additional housing, business equipment and public infrastructure to accommodate the extra workers and their families, this lack of "capital widening" reduces our physical capital per person and so reduces our productivity.

Think of it: the very report announcing that our population is projected to grow by 16 million to 40 million over the next 40 years doesn't say a word about the huge increase in infrastructure spending this will require if our productivity isn't to fall, nor discuss how its cost should be shared between present and future taxpayers.

No, none of that. Just another repetition of that peculiarly Australian doctrine that pretty much the only way to improve productivity is to engage in unceasing micro-economic reform.

Read more >>

Why monetary policy stimulus is less effective

The advent of "stagflation" in the 1970s - the previously unknown combination of high inflation with high unemployment - led to a loss of confidence in Keynesian policies, with primary responsibility for management of the macro economy being shifted to monetary policy and with fiscal policy taking a lesser role.

Four decades later, the wheel may be turning again. The two hot stories in the world of macro management are the decline in effectiveness of monetary policy and a consequent resurgence of interest in active fiscal policy.

Last week Dr Philip Lowe, deputy governor of the Reserve Bank, gave a speech explaining the monetary policy story, so let's look at that today and leave the fiscal story for another day. (Monetary policy refers to the central bank's manipulation of interest rates - and, these days, its creation of money - and fiscal policy refers to the government's manipulation of taxation and government spending in the budget.)

In the aftermath of the global financial crisis of 2008, the big developed countries' central banks cut their official interest rates virtually to zero in their efforts to stimulate demand, avert a depression and get their economies moving again.

When this didn't seem to be having much effect, but being unable to cut their official rates below what economists pompously call "the zero lower bound", first the US and Britain, then Japan, then the euro zone resorted to an unorthodox practice known as "quantitative easing": central banks buying bonds from the commercial banks and paying for them by creating money out of thin air.

The main way this stimulated their economies was by pushing down their exchange rates relative to the currencies of those countries that didn't resort to QE - us, for example.

The Europeans got so desperate to get their economies moving their next step was to do something formerly believed impossible: they cut their official interest rate below zero - meaning the central bank charges its commercial banks a tiny percentage for allowing them to deposit money in their central-bank accounts. In a few cases, the commercial banks have passed on this "negative interest rate" to their business depositors.

As Lowe says, the present global monetary environment is "quite extraordinary". There's been unprecedented money creation by major central banks, official interest rates are negative across much of Europe, long-term government bond yields (interest rates) in most advance countries are the lowest in history and lending rates for many private-sector borrowers are the lowest ever.

Had anything like this much stimulus been applied in earlier decades, economies would be booming and inflation would have taken off. Instead, though the US and British economies are now growing moderately, Japan and the rest of Europe remain mired, with considerable idle capacity. Inflation rates are low almost everywhere and inflation expectations have generally declined, not increased.

But why have things changed so much? Lowe says it's partly because the GFC was the biggest financial shock since the Great Depression and so has required a much bigger dose of monetary stimulus than usual, which is taking longer than usual to work.

But it's also partly because monetary policy is less effective. "Economic activity does not appear to have responded to the stimulatory monetary conditions in the way that occurred in the past and inflation rates have been very low," he says.

The single most important factor causing the change, he says, is the very high levels of debt now existing in many advanced economies.

One of the "channels" through which stimulatory monetary policy works is by the lower interest rates encouraging people to borrow so as to bring forward future spending. This has worked well in the past, but the high stock of debt acquired from past episodes has left many households, businesses and banks (and even in some cases, perversely, governments) unwilling to add to their debt.

Rather, they're using the low interest rates to help "repair their balance sheets" by paying down their debts.

One aspect of easy monetary policy that is still working normally, however, is the rapid rise in the prices of assets such as property and shares.

Another thing that's different is the flow-on from demand to prices. Both workers and firms seem to perceive their pricing power to have been reduced. More worried about keeping their jobs, workers are accepting much lower wage rises. More worried about losing customers, firms are more cautious about putting up their prices.

So how is all this affecting us in Australia? Lowe says one big effect is to leave us with an exchange rate that's higher than it should be; that hasn't fallen as much as the fall in our mineral export prices implies it should have.

This has required the Reserve Bank to cut our official interest rate by more than it thinks ideal. It's done this partly to reduce our interest rates relative to other advanced countries' rates and so put some downward pressure on our dollar, but mainly to make up for the inadequate stimulus coming from the still-too-high exchange rate.

The big drawback to our very low interest rates is the boom in asset prices: for shares and, more worryingly, houses.

Second, Lowe says, the same factors affecting global monetary policy are evident in Oz, although to a lesser extent. Our banks, businesses and governments don't have excessive levels of debt, but our households do. So, many are using the fall in mortgage interest rates to step up their repayments of principal rather than increase their consumer spending.

Retirees living on interest earnings seem to have cut their consumption rather than eat into their capital.

Our wage growth is surprisingly low, contributing to low inflation.

Lowe's conclusion, however, is that our monetary policy is still working. And once the major advanced economies have fully recovered from the Great Recession - which could take as long as another decade - global monetary policy will return to normal.

Read more >>

Tears for first-home buyers the crocodile kind

Joe Hockey wants to help young people buy their first home by letting them dip into their superannuation, while NSW Labor leader Luke Foley wants to improve affordability by letting them pay off the stamp duty on their purchase over five years. Really? I often wonder whether our politicians are knaves or just fools.

But while we're questioning the sense and morality of our pollies, we shouldn't neglect to ask whether they're just reflecting our own weaknesses. There are few subjects on which more crocodile tears are shed than housing affordability.

At bottom, the economics of housing affordability is dead simple. Sometimes housing can be hard to afford because mortgage interest rates are way too high. But that hasn't been the case since we got inflation back down to normal levels in the mid-1990s.

And at present just the reverse applies. Mortgage interest rates are abnormally low. They won't stay that way, of course.

Advertisement

So if interest rates aren't the problem, the other factor is home prices. In a market economy like ours, the price of anything – whether ordinary goods or services, or an asset such as a house – rises when the demand for it exceeds its supply.

For some years now, the supply of additional houses and units has failed to grow in line with "household formation" – young people getting married, people immigrating to Australia and couples splitting up.

So inadequate growth in supply has been the real problem, caused by state and local governments placing too many legal obstacles and charges in the path of developers seeking to build new estates on the edge of the city and – perhaps more important – seeking to provide medium- and high-density "infill" closer in, where people increasingly prefer to live to avoid long commutes.

The NSW Coalition government claims to have made progress in reducing these obstacles, and it's true that housing construction is growing faster in Sydney at present than it has been.

But though the basic problem has been maintaining an adequate supply of appropriately located housing to meet the growing demand, the supply side of the problem isn't terribly visible to you and me.

We're more conscious of the demand side, represented by the high and ever-rising cost of buying a place faced by our kids and other young people. What's more, we suffer from a kind of optical illusion. Your daughter and her partner are just sitting there saving, watching some invisible force push house prices further and further out of their reach.

The trick is that while no single purchaser can move the market price, the combined demand of all purchasers can – and does, as we watch.

Our natural, uneducated tendency to see the house price problem from the viewpoint of the individual buyer makes us susceptible to the pseudo solutions peddled by politicians seeking votes.

If only my daughter could get a bit of a leg-up in either putting together a sufficient deposit (say, by being allowed to dip into super) or in lowering the initial cost of the purchase (say, by staggering the cost of stamp duty), she could afford to take on the mortgage and she'd be right.

See the weakness in that logic? If it helps your daughter and her partner, it also helps all the couples they're competing against to buy a place. Which means it gets your daughter nowhere. Actually, she's worse off. Since everyone can now more easily afford to pay the existing price, the prices of the homes they want to buy go even higher.

As economists say, the benefit from the caring pollie's supposed helping hand is "capitalised" into the price of "ideal first homes". And that means the benefit of the measure ends up going not to first-home buyers but to first-home sellers.

Economists have understood this perverse outcome since the year dot. Their rule is simple: when demand for housing is running ahead of supply, anything you do to make it easier for people to afford the high prices ends up only making prices higher, to the cost of buyers and the benefit of existing home owners.

It's possible Hockey and Foley aren't sufficiently economically literate to have worked out that their proposals would be counterproductive. (Not to mention that Hockey's would leave young people's eventual retirement payouts significantly diminished because of their loss of compound interest, or that Foley's would leave fully financially committed couples with additional large lump-sum payments for five years.)

What's not credible is that these guys' economic advisers would have failed to warn them of the perverse consequences of their proposals. So they may just be fools, but my practice is to give their intelligence or competence the benefit of the doubt and assume they're knaves: they knew it was a con, but were confident most voters wouldn't see through it, so they proposed it anyway.

And remember this: in any year, the number of voting home owners far exceeds the number of would-be home owners. So how could proposing a scheme that pretended to help first-home buyers while actually helping existing home owners cost you more votes than it gained?

The pollies know that proposing phoney schemes to help young home buyers without actually lowering the value of the homes owned by the rest of us is exactly the kind of help we prefer them to offer.

Read more >>

Econocrats doubt our ability to grow

So, how fast can we expect the economy to grow over the next 40 years? And, more to the point, where's that growth supposed to come from? That's a doubt you expect from people without the benefit of an economics education, but the intergenerational report reveals the econocrats are going through a crisis of confidence about growth.

First, a disclaimer: not being as materialist as the economists, I don't see maximising our material standard of living as the ultimate objective. I worry more about what climate change and resource depletion will have done to the economy in 40 years' time, and the social price we'll be paying for our obsession with the material.

But back to the dominant paradigm.

The report projects that growth in real gross domestic product will slow to an average rate of 2.8 per cent a year over the next 40 years, down from 3.1 per cent a year over the past 40.

A third of this decline is explained by slightly slower population growth, leaving average growth in real GDP per person falling from 1.7 per cent a year in the past to 1.5 per cent a year in the future.

I trust you're suitably shocked and dismayed. This projected decline is explained essentially by the ageing of the population, leaving the average rate of improvement in the productivity of labour unchanged between the past and the future at 1.5 per cent a year.

So, where will the growth be coming from? Exclusively from improving productivity: from the economy's output of goods and services growing faster than its inputs of labour.

It's productivity the econocrats and other economists are so pessimistic about. So how did they estimate that productivity will grow by an average of just 1.5 per cent a year?

They didn't. They simply followed previous practice and plugged in the same figure for the coming 40 years as for the past 30. Since it's impossible to know what will happen to productivity in the future, this neutral assumption is better than any other you could make.

But that hasn't stopped some economists from claiming that 1.5 per cent a year is overly optimistic. Really? This tells you something about the reigning mood of pessimism among economists.

But if income per person is driven by productivity improvement, what drives productivity? If you rely on the things economists say in public, you could be forgiven for not knowing that overwhelmingly – and for the past 200 years – it's technological advance.

Every economist knows that's true but they rarely say so. That's partly because they know little about how technological advance works and partly because they believe there's little they can do to affect it.

But in recent years, some leading overseas economists have lost their faith that rapid technological advance will continue lifting material living standards. Two centuries of innovation have hit a dry spot, we're told.

It seems Treasury agrees. It admits a fact rarely included in economists' unceasing sermons on the evil of our low rate of productivity improvement in recent times: "Australia has not been alone among advanced economies in experiencing slower productivity growth over the 2000s, which suggests that the rate of growth in technological advance . . . may have been slower than in previous decades."

So if we can't rely on a continuing stream of new technology to keep our living standards growing at a rate economists find acceptable, what does Treasury suggest? It was hoping you'd ask because it's got just the solution we need: more microeconomic or "structural" reform.

For several years, all right-thinking economists have been badgering us to pressure governments for more micro reform. To bolster its argument that micro reform is the missing elixir, Treasury says "the increase in productivity growth rates seen in the 1990s is widely attributed to significant policy reforms of that decade and the 1980s".

But even if you believe this (I'm sceptical), it's hardly a great advertisement for the benefits of reform. You can make the most sweeping reforms – reforms which, having been made, can't be repeated – and all you get for your pains is four or five years of improved performance before lapsing back into mediocrity.

Reform, we're asked to believe, is only a fleeting fix. To maintain an acceptable rate of productivity improvement, reform must be unceasing (and defy the law of diminishing returns).

This portrays our economy as hopelessly inefficient and unproductive, despite all our efforts. Other countries can grow satisfactorily without continuous reform, but we can't.

Really? Such a view is so deeply pessimistic as to verge on economic apostasy. It's also bizarre.

Read more >>