Wednesday, March 18, 2015

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.
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Monday, March 16, 2015

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.
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Saturday, March 14, 2015

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.
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Wednesday, March 11, 2015

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.
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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 >>

Monday, March 9, 2015

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.
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Saturday, March 7, 2015

More infrastructure spending would boost economy

It's good to see Joe Hockey finally making the transition to government and joining the economic optimists' party. This week he greeted the national accounts by saying the economy had grown by "a solid 0.5 per cent in the December quarter to be 2.5 per cent higher over the past year".

"Our income as a nation picked up in the quarter, with nominal gross domestic product rising by a solid 0.6 per cent," he continued. "Real gross national income also rose in the quarter."

A treasurer should never talk the economy down, just as the official forecasters should never be the first to predict imminent recession. Such negativity tends to be self-fulfilling.

So I'm sorry to rain on Hockey's parade by telling you that "solid" growth is the econocrats' euphemism for "not so hot".

Just so. Annual growth of 2.5 per cent is well below our trend (average) rate of 3 per cent, especially disappointing when you remember we've been well below trend for quite a few years.

But though the figures from the Bureau of Statistics were unsatisfactory, they don't support the earlier fears of some that the economy fell apart in the previous quarter. A sensible reading is that the economy continues to plug along at the rate of about 2.5 per cent a year.

This, of course, is insufficient to stop unemployment rising. But for some years the rate of worsening has been steady at about 0.1 percentage points a quarter – which fits with reasonably steady growth in real GDP of about 2.5 per cent a year.

One encouraging sign in the accounts is that consumer spending grew by 0.9 per cent in the quarter and 2.8 per cent over the year. This isn't too bad when you consider that, with weak growth in employment and wages, real household income is growing at an annual rate of only about 1 per cent, according to calculations by Kieran Davies of Barclays bank.

Clearly, households must be reducing their rate of saving. Over the past year it's edged down by about 1 percentage point to a still-high 9 per cent of household disposable income. From now on consumer spending should be boosted by the fall in petrol prices.

Another bright spot is home building, which grew by 2.5 per cent in the quarter and by more than 8 per cent over the year. This is one area where the Reserve Bank's exceptionally low interest rates are really working, with building approvals reaching an all-time high in January.

It's likely all the real estate activity is helping to boost consumer spending on durables. There's nothing like changing houses to make you think you need a new lounge suite.

The weakest part of the accounts was business investment spending, which fell by almost 1 per cent in the quarter. Within this, and according to Davies' figuring, mining investment fell by 5 per cent while non-mining investment grew by only 2 per cent.

This is where we need the economy to be making the transition from the mining investment boom to non-mining-led growth. It's happening, but not fast enough to get the economy heading back towards trend growth.

That's why the Reserve has reverted to cutting interest rates. Not so much because the economy was slowing as because it wasn't picking up the way it had expected. And it's early days yet: mining investment fell by about 13 per cent last year, it's expected to fall by about that much again this year and by a lesser amount in 2016.

Arithmetically, the big saviour was the rising volume of exports, up 1 per cent in the quarter and more than 7 per cent over the year. This was driven by mineral exports, of course.

Combine that with a 2.5 per cent fall in the volume of imports in the quarter and "net exports" (exports minus imports) contributed 0.7 percentage points to GDP growth in the quarter and 2 percentage points to growth over the year.

Why are imports falling? Mainly because less mining investment means fewer imports of heavy mining equipment, but also because the fall in the dollar seems to have discouraged imports of business services and Aussies from "importing" overseas holidays.

But I can't get too excited about the surge in mineral exports. Mining is so capital-intensive that far fewer jobs are created by higher mineral exports than you'd expect from a jump in other exports. If that's the best we've got going for us, it's not good enough.

One more point of interest: spending by the public sector rose by a mere 0.1 per cent in the quarter and actually fell by 1.1 per cent over year. So, no help from government spending in getting the economy moving.

But before you start muttering about "austerity" and blaming poor old Joe, note this: public consumption spending rose by 0.4 per cent in the quarter and by 2 per cent over the year, whereas public investment spending fell by 0.9 per cent in the quarter and by (an amazing) 11.9 per cent over the year.

The great bulk of spending on capital works – "infrastructure" if you prefer – is done by the state governments. So it seems that, between them, the state governments – unduly worried about retaining their high credit ratings – have been allowing their works programs to run down.

This at a time when so many mining construction projects are winding up and construction workers and other resources are becoming available. Sensible governments adjust their construction programs to fit with downturns in private sector activity and take advantage of lower construction costs, thereby doing themselves and the economy a favour.

With monetary policy (interest rates) now less effective in stimulating the economy, it would be better if fiscal policy (budgets) was doing more to help, not less.
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Friday, March 6, 2015

Intergenerational report a disappointment

The five-yearly intergenerational report ought to be highly informative, leading to serious debate about the economic choices we face. In the hands of Joe Hockey, however, it has become little more than a crude propaganda exercise.
As such it will be quickly cast aside, like last year's report of the Commission of Audit. Within a few days all that will remain is the taxpayer-funded advertising campaign. It, too, will be more about spin than brain-food.
Hockey has shifted the report's focus from the next 40 years to the government's present struggles with the budget. The message he wants us to take away is that it's all Labor fault, but the government has worked hard to greatly reduce the problem. And were not for those crazies in the Senate - who seem to think our spending cuts were unfair - last year's budget would have set us up for budget surpluses right through to 2055.
The message we should take away from it, as with its three predecessors, is one no politician on either side is prepared to admit: as our demands on the government for more and better services continue to grow, we will have pay for them with higher taxes. Since our real incomes are projected to rise by almost 80 per cent, this won't be so terrible.
Instead, the message from all these reports is that there is no alternative to sweeping cuts in government spending, unfair or not.
They come to this conclusion by quietly assuming that before long we will return to annual tax cuts, even as the budget deficit and debt get bigger every year. Sure.
If you wonder how anyone could have any idea of how things will play out over the next 40 years, you are right. No one can. The one thing we can be sure of is that, whatever the budget and the economy end up looking like in 2055, it won't be what this report says they will.
The mechanical projections in this report are based on a host of assumptions about an unknowable future. Some of those assumptions are spelt out in the fine print, some aren't. Some are honest guesses, some have been chosen to lead us to the conclusions the government wants us to reach.
One demonstration that projecting what will happen over the next 40 years is unavoidably dodgy is that the four successive reports have each come up with widely differing figures for where the budget will end up.
One demonstration of the report's lack of genuine concern about our future is its dismissive treatment of climate change. The biggest risk we face in 40 years' time is the budget deficit?
One demonstration of the report's inadequacy is its failure to take account of what may be happening to the state governments' budgets. This allows it to claim last year's budget measures would have restored the feds to eternal surplus, while ignore the consequences of Hockey's proposal for ever-growing cuts in grants to the states for hospitals and schools. Really?
To be fair, before Hockey got into the act Treasury would use the intergenerational report for its own propaganda. Its message was aimed at its political masters: the budget may look OK now, but there is a lot extra spending coming in a few years' time, so keep running a tight ship.
It was spectacularly unsuccessful. The Howard government went mad with tax cuts and middle-class welfare and Rudd and Gillard were a fraction worse with their unfunded schemes to help disadvantaged school kids and the disabled.

And these guys think it's all our fault?
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Wednesday, March 4, 2015

Cities: jobs in the centre, most people on the outer

It's remarkable how few new ideas most economists get. They look at the world the way they always have and worry about the same things they've always worried about, chasing the same rabbits down the same burrows.
They analyse the world using their standard model and see those things the model is designed to highlight, but don't see anything that's outside its scope.
What most economists rarely think about is the spatial dimension of the economy. It's ignored by their model, so it's ignored by them. Could it have something to tell us about why the economy isn't functioning as well as it could? Who knows?
Jane-Frances Kelly and Paul Donegan, that's who. They've been studying the economics of our cities for the Grattan Institute, and their eye-opening findings are explained in their new book, City Limits: Why Australia's cities are broken and how we can fix them. Here's my version of their message.
Despite our self-image as sun-bronzed sons and daughters of the soil, we are a nation of city-dwellers. Australia is one of the most urbanised countries in the world.
Our capital cities are growing and most of our income is being generated in them, notwithstanding the big expansion in mining, which is more about additional structures and capital equipment than workers.
For at least the past 40 years, all the net increase in employment has been in the services sector, and the services sector exists mainly in cities. The arrival of the knowledge economy will only heighten this trend.
Most of the economic action in our capitals is occurring near the centre of the city. Just the Sydney and Melbourne central business districts – occupying a combined area of a mere 10 square kilometres - account for about a quarter of each city's production.
Businesses crowd into the CBD because it gives them the easiest access to desirable employees and because they benefit from being close to the other firms in their industry and their suppliers. It facilitates the transfer of knowledge. Get it? They think that crowding together increases their productivity.
The biggest trend in city property prices is not just big rises over time, but the way inner-city prices are rising so much faster than outer-city prices as people seek "proximity" – closeness to the centre, with all its facilities and jobs.
Researchers at the Reserve Bank have shown that if you draw a graph with home prices on the vertical axis and distance from the CBD on the horizontal axis and then plot actual prices, you get an almost perfectly downward-sloping curve for Sydney, Melbourne, Perth or Brisbane. On average, prices are highest close in and lowest far out.
For the five mainland state capitals, 60 per cent of all the employment growth over the five years to 2011 occurred within 10 kilometres of the centre. But here's the problem: no doubt because inner-city house prices were so high, about 55 per cent of the population growth occurred 20 kilometres or more from the centre.
In other words, we've been developing a big economic and social problem few economists have noticed: a growing spatial divide between where the jobs are and where people live.
It's an economic problem because it increases the economy-wide costs of each day's production of goods and services. It's a social problem because, for the most part, those costs fall on the less-wealthy working families living in outer suburbs. Some of the costs come as dollars paid, some as time wasted and some as opportunities forgone.
The growing distance between where we live and where we work means car travel in peak periods is getting slower in all capital cities. Traffic is slowest on inner-suburban roads, because that's where most people are travelling to or from.
Over the past decade, the proportion of people spending more than 10 hours a week commuting has increased by about half. One in four full-time employees spends more time commuting than with their children.
Women caring for children in outer suburbs face tough choices, with a lack of accessible jobs forcing some out of the workforce altogether.
So what can we do about it? We need to reduce congestion and make it easier, quicker and cheaper to move across the city. To me that means improving access to public transport – which is excellent in the inner-city and woeful in the outer suburbs – not returning to our earlier delusion that building more expressways will fix it.
One day we'll have the courage to use time-of-use tolling to encourage those who have the flexibility to avoid travelling in peak periods to stop doing so.
But improving public transport is expensive and can be only part of the solution. The authors stress the need to increase the supply of semi-detached homes – terraces, townhouses and low-rise blocks of flats – in inner and middle suburbs.
This would require changes to complex planning and zoning regulations – and a lot of public consultation if the changes are to stick. But if so many people want to live closer in, we need to accommodate their wishes.
With the release of another intergenerational report this week, we'll be hearing much agonising by politicians and economists about why our productive efficiency isn't improving fast enough. But don't hold your breath waiting for them to acknowledge that a fair part of their problem is spatial.
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Monday, March 2, 2015

Treasury under new management

How much does the Treasury's view of the world change when a prime minister comes to power, sacks the head of Treasury (and his heir apparent) and replaces him with his own hand-picked man from outside the public service?

That's what the economic cognoscenti were asking last week when our first political appointment as Treasury secretary, John Fraser, made his first public appearances at a Senate estimates hearing and as a speaker at a conference of the Committee for Economic Development of Australia.

Fraser had risen to the rank of deputy secretary when he left Treasury in 1993 to make his name and fortune as an investment banker at the global level of the UBS bank. It's hard to imagine such an old and rich chap would hang around long if he found his advice wasn't being heeded.

From what he's said so far, you don't get the feeling Fraser has spent the past 22 years keeping tabs on the Australian economy or keeping abreast of the latest applied research on fiscal policy. Even so, he's a man of strong and confidently held opinions, who isn't afraid to tell you about them.

His views were pretty conservative when he left Treasury, at a time when the views of Treasury itself were more cautious than they've been in recent years, and his time as a chief executive is unlikely to have radicalised him.

Dr Martin Parkinson and Dr Blair Comley seem to have been sacked for their lack of scepticism about climate change, so we can presume Fraser doesn't share that failing. I may be wrong, but I don't see him as someone who wastes much time worrying about "wellbeing frameworks".

We know from his evidence to the Senate that he's a great admirer of Ronald Reagan's tax cuts of the early 1980s (which did so much to lay the foundations for America's present towering public debt), but has "old-fashioned" views about the evil of public debt.

He is sceptical about using the budget to stimulate the economy when it's very weak – which means he's invalidated one of the best arguments for getting debt down: the need to "reload the fiscal cannon" ready for the next recession.

And he thinks the policy of "austerity" practised in Britain and (by default) America has been a great success. This opinion he expressed to the Senate and backed up with figures in his later speech.

To silly people on the left, "austerity" is a swear word you slap on any budget saving you disagree with. But it really means a policy of cutting the budget deficit hard even while the economy is very weak.

The lefties never understood that Joe Hockey's first budget was carefully crafted to involve minimal net cuts to the deficit in the first three years, with the big hit delayed until 2017, when the economy was expected to be back growing strongly.

So, is true austerity about to come to Oz under the advice of the new Treasury boss? You might think so. Fraser says "we need to start now" and repairing the fiscal (budgetary) position is "an immediate priority".

But I'm not so sure. Later in his speech he advocates "committing now to savings measures that build over time to deliver a return to surplus over the medium term". And asked if now was the time to cut savagely considering the weak outlook, he said the coming budget would have to be "tailored to the situation".

While much of what Fraser has said so far is what you'd expect of an Abbott appointee, some of it isn't. His summary of how the budget got into its present state doesn't put all the blame on Labor, but acknowledges the role of excessive tax cuts and spending by the Howard government.

And while noting that government spending has grown at an average real rate of more than 4 per cent a year since 2007-08 (mainly under Labor), he also noted that it grew by about 3.5 per cent a year over the four years to 2007-08 under the sainted Howard government.

He is sharply critical of the increase in "middle-class welfare" in Howard's last years, including Peter Costello's (obviously unsustainable) superannuation changes, which he highlights for reform.

And unlike the huge majority of economists, he frankly admits the great drawback to using immigration to boost economic growth: it "places additional demands on government budgets in areas such as infrastructure, health and education".

Maybe high immigration, but inadequate investment in business equipment, housing and public infrastructure, help explain why our rate of productivity improvement isn't as great as Fraser says we need.
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