Monday, August 17, 2015

Shift to services is boosting exports and jobs

For economy watchers, the most fascinating game in town is the continuing effort to explain why employment and unemployment are performing better than you'd expect while growth in the economy has been so modest.

Despite the Bureau of Statistics' latest national accounts showing that real gross domestic product grew by just 2.3 per cent over the year to March, its smoothed seasonally adjusted labour force figures show employment growing by 2.1 per cent – or 240,000 jobs – over the year to July, with the rate of unemployment seeming to have stabilised at about 6 per cent.

So far in the Reserve Bank's efforts to explain this puzzle, we've heard that it's probably a consequence of slower than expected population growth, helped by surprisingly weak growth in wage rates.

But now an assistant governor of the Reserve Bank, Dr Christopher Kent, has used a speech to the Economic Society in Brisbane to add a third factor: the employment consequences of the economy's accelerated shift from goods to services.

Recent figures show that total population growth has slowed from 1.8 per cent in 2012 to 1.4 per cent in 2014. This slowdown is mainly the result of a decline in the rate of net immigration as skilled workers on temporary 457 visas attracted by the resources boom leave for home when their jobs end, and Kiwi workers go home or stay home.

Slower population growth means slower growth in demand but, equally, slower growth in the population of working age and thus in the economy's supply-side potential or "trend" rate of growth.

This has prompted the Reserve to lower its growth forecasts for 2016 a fraction but eliminate its earlier forecast of rising unemployment, leaving it little changed over the next 18 months.

Since the working population hasn't grown as fast as had been expected, this implies the improvement in the productivity of labour has been a fraction greater than first thought.

Last week's figures from the bureau show wage rates rising just 2.3 per cent over the year to June. Wage growth has slowed to a similar extent as happened in the recession of the early 1990s, even though unemployment has risen by much less than it did then.

Kent says wages may have become more flexible over time and there may have been some general decline in the bargaining power of labour.

Whatever, "low wage growth across the economy has enabled firms to employ more labour than would otherwise have been the case".

But Kent says his sense is that "low wage growth only goes some way to explaining the recent pick-up in labour demand".

Now the likely role of a change in the composition of economic activity. Consumer spending, home building and net exports of services (that is, exports of services minus imports of services) have grown reasonably strongly over the past year, even though overall GDP growth has slowed a fraction.

Surveys suggest that business conditions for firms providing services to households have improved greatly since mid-2013. Conditions for firms providing services to businesses are above average. But those for firms producing or distributing goods remain below average.

These survey results line up reasonably well with employment growth in the three sectors. They also fit with the continuing weakness in business investment spending.

Kent's figuring shows, on average, each worker in the household services sector requires the backing of only about $100,000 worth of capital equipment, whereas each worker in the goods sector (including mining) requires capital equipment of almost $400,000.

Get it? If the fastest-growing parts of the economy are labour-intensive, they can grow and create more jobs without this requiring the same degree of increase in business investment spending and, hence, the same degree of overall growth in the economy.

This compositional change in demand from goods to services – from capital-intensive to labour-intensive industries – is a long-term trend.

But Kent argues there is also a cyclical element to it, as mining investment unwinds and growth in housing construction and consumption – which is increasingly dominated by services – picks up.

Another part of it is that the fall in the dollar has encouraged Australians and foreigners to direct more of their spending to Australian tourism, education and business services.

Over the past three years, the extra workers employed in service industries have outnumbered the extra workers employed in the goods sector by five to one.

It adds up to two things. With slower population growth, we can grow more slowly without being worse off materially. And we don't need to grow as fast to get unemployment falling.
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Saturday, August 15, 2015

Micro reform: what Treasury wants to change

Under its newish secretary, John Fraser, Treasury has a new slogan. It is proud to be "fiscally conservative, market-oriented and reform-driven". So just what reform does Treasury advocate?

Well, in a speech last week Fraser spelt it out. But first he noted that the key element of market-oriented reform is that it almost always involves heightening competition. He illustrated the point by summarising what happened during the golden age of micro-economic reform in the 1980s and '90s.

When business speaks of the need for Australian firms to be more competitive, it usually means  the government should do something that makes it easier for firms to compete with their foreign rivals.

But this is the opposite of what economists mean when they see heightened competition as the key driver of improved economic performance. They mean Australian firms should be forced to improve their own performance by exposing them to greater competition with other Aussie firms and by making it easier for foreign firms to compete with them.

As Fraser explains, competition is at the heart of how market economies are organised. "Competitive markets generally deliver benefits for all Australians in a way that sheltered markets fail to do so," he says.

"Effective competition in our economy is a key part of its strength and dynamism. Competitive markets benefit consumers by putting downward pressure on prices.

"And over time, competitive pressures drive innovation and investment in new technologies and the development of new products and quality services that meet the needs of consumers. This process of innovation is what drives economic growth and improvements in living standards in the long term."

The modern era of opening Australia to greater pressure from the world economy began when Gough Whitlam cut import tariffs in 1973, he says.

Successive tariff cuts in the '80s and '90s "put Australian manufacturing under increased competitive pressure but, behind the border, changes gave manufacturers flexibility to respond".

Significant among these changes were financial market deregulation and the move to enterprise bargaining, as well as the oft-forgotten reductions to the top personal marginal tax rate from a 60 per cent in 1985-86, to 47 per cent in 1990-91, Fraser says.

The process of reform culminated with the agreement across all levels of government to form the "national competition policy" that began in 1995 and ran through to 2005.

Government businesses were restructured to make them more commercially focused. The electricity, gas, water and rail sectors were transformed.

Legislation was reviewed so it enhanced rather than restricted competition. And a national access regime was established for essential infrastructure. That is, the public or private owners of monopoly networks were obliged to make them available to competitors at reasonable prices.

"Where creativity was once stifled by regulation, competition in product and service markets drove management to change work practices. A liberalised financial sector and a sound macro-economic environment supported strong investment."

Fraser says this era of huge changes offers three lessons on how to get policy reforms accepted.

"First, it was a holistic set of structural reforms. This is important because winners and losers differed and all Australians benefited from at least some of these reforms.

Second, in order to achieve reform we built a political consensus and, more importantly, a community consensus that things had to change and that a delay would make matters worse.

Third, the business community – both large and small – was a big part of this changing culture.
"Managers, no longer distracted by currying [for] government protection, were better able to focus outwards on new markets and inwards on cost savings."

So what's on Treasury's latest reform to-do list? Tax reform, for one. Then there's the financial system. Australia's banking system is relatively concentrated by international standards and the Murray financial system inquiry recommended that regulators increase the emphasis on competition relative to their other objectives.

Then, labour market reform. "I am heartened by Peter Harris and the Productivity Commission's report on workplace relations. Genuine reform  ... can be expected to have positive effects on employment and productivity and to reduce business compliance costs."

Next, competition laws. "It is important that firms that have market power are not able to use that position to exclude competitors and potential competitors. This is why we have competition laws."

The review of competition  by Professor Ian Harper found that current  laws need to be overhauled to make them fit for purpose.

"There remain substantial restrictions on who can supply goods and services, including: professional licensing requirements, liquor and gambling regulation, media and broadcasting restrictions , and the well-known issues of pharmacies and taxis," Fraser says.

"There are restrictions on what can be supplied through product standards, agricultural marketing boards, parallel import restrictions and intellectual property protections. And restrictions on where and when supply can occur: air service agreements, retail trading hours restrictions, and planning and zoning rules."

Fraser concedes that the goal here should not always be deregulation. Regulations are often justified to pursue social goals. "But these goals should be approached through better regulation that doesn't have the side effect of curtailing competition.

"To my mind, foremost among this list, for immediate economic bang for the buck, is planning and zoning."

Planning and zoning systems may create excessive barriers to the entry of new businesses  by limiting  number and size of outlets and  types of business models permissible.

"In other areas, the challenge for governments is not so much to reform regulation as to make way for 'digital disruption'. Uber  connects passengers with drivers and AirBnB  connects travellers with spaces.

"We should welcome competition here too – governments should not be too quick to assume they will always be better regulators than the private sector."

Clearly, Fraser has an ambitious agenda. It's different to mine, but sometimes my duty is to make sure you know what the econocrats are thinking.
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Wednesday, August 12, 2015

Our poor treatment of mental illness is costing us

Don't take this as implying that I condone the misuse of taxpayers' money, but the almighty to-do over politicians' "entitlements" reminds me that small things annoy small minds.

If you think the odd unnecessary $5000 helicopter ride constitutes the worst of the wastage of our money – or that it makes much difference to the $430 billion the federal government spends each year – you haven't done enough thinking.

As several people reminded me at the Byron Bay Writers' Festival at the weekend, such matters as politicians' pay and perks pale into insignificance compared with the threat to our way of life posed by climate change and other continuing environmental damage.

My conscience tells me that, for as long our response to that threat remains so inadequate – including our inadequate contribution to the success of the Paris climate change conference in December – I shouldn't be writing about anything less consequential.

But we ought to be able to juggle more than one problem at a time, and although climate change is our most pressing problem, it's far from our only one.

One combined threat and opportunity that 'coptergate prevented from getting the attention it deserved last week is one we should have been on to long ago. It was raised in a noteworthy speech to the National Press Club by Professor Allan Fels, now chairman of the National Mental Health Commission (and with a family interest in the topic).

Fels' point was that we've been making a hash of mental health for ages, but that if we got our act together, we could not only reduce the misery of up to 3.7 million Australians, but eventually do everyone else a favour.

Fels is, of course, a professor of economics. So he spoke with authority when he argued that mental health is not just a significant social issue – although that should be enough to make us pay attention – it's a significant economic problem as well.

"Mental health is a significant problem for our economy – as significant as, often more significant than, tax or micro-economic reform," he says. (More significant than tax? Not possible.)

"Many people do not get the support they need, and governments get poor returns on substantial investment. The economic or gross domestic product gains from better mental health would dwarf most of the gains – often modest ones – being talked about in current economic reform debates."

The Organisation for Economic Co-operation and Development estimates that the average overall cost of mental health problems to developed countries is about 4 per cent of GDP. In Australia, this would equate to more than $60 billion a year, or about $4000 for each person who lodges a tax return, or more than $10,000 a family.

Those costs include the direct costs of treatment, plus the indirect costs, such as disability support pensions, imprisonment, accommodation and so on, plus the costs of lost production and income, plus the costs to carers and families and their reduced participation in the workforce.

But just what is the mental illness we're talking about? Of the 3.7 million Australians estimated to have mental health problems in any year, 3 million have a mild to moderate condition, such as anxiety or depression at a clinical level.

It's because so many people with "common" mental disorders are employed – and unemployed – that mental ill-health has such big implications for economic production and productivity. It causes about 12 million days of reduced productivity each year, arising from absenteeism and "presenteeism" (being at work but not getting much done).

The remaining 700,000 people have persistent complex and chronic illness, such as schizophrenia or severe depression.

Seven people die every day from suicide, about double the road toll. But while the number of deaths on our roads has diminished substantially, there has been no major reduction in the suicide rate over the past decade, we're told.

Death from suicide among Aboriginal and Torres Strait Islander peoples is twice that of non-Indigenous Australians.

Fels says there are excellent examples of suicide prevention, treatment, follow-up and "postvention" in Australia.

Even so, the government review conducted by Fels concluded that much of the $10 billion a year the feds spend on mental health "is neither effective nor efficient".

Almost 90 per cent of it is spend on "downstream programs", such as income support for sufferers, payments to support state hospitals and mental health-related medical and pharmaceutical benefit payments.

"Much of this is payment for failure, payment for failure to treat the problems early and cost-effectively," Fels says.

"I believe this heavy expenditure could be reduced with greater emphasis and investment in prevention, early detection, a focus on recovery from mental ill-health and the prevention of suicide."

If we enable people to live contributing lives – to have relationships, stable housing, and to maximise participation in education, employment and the community more broadly – we will help build economically and socially thriving communities and a more productive Australia, Fels says.

I'm not a believer that things we should be doing for social or cultural reasons must first be asked to justify themselves on economic grounds. We're rich enough to afford to look after those among us with problems, and to pursue knowledge for its own sake.

But the argument that doing better on mental health would improve economic outcomes seems unassailable.
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Monday, August 10, 2015

Don’t be sure lower penalties mean more jobs

The argument that reducing or eliminating weekend penalty wage rates would have great economic benefits is obvious to all business people and economists – but not to me. I think it's fallacious.

The received wisdom was well expressed by Anna McPhee, of the Retail Council: "The rebalancing of penalty rates to reflect the needs of the modern economy will mean retailers can create jobs to meet increased consumer demand, which in turn will benefit the economy more broadly."

She was responding, of course, to the proposal in the Productivity Commission's draft report on Australia's Workplace Relations Framework that Sunday penalty rates in the hospitality, entertainment, retailing, restaurant and cafe industries be cut to the same level as Saturday penalty rates.

Even the commission goes along with the received wisdom: "Excessive penalty rates for Sundays reduce hours worked, mean unemployment is higher than it needs to be, and reduce options for businesses and consumers. Trading hours are likely to be lower and capital under-utilised."

But I believe such thinking rests on a fallacy of composition, that what's true for the individual must be true for the whole.

It's not hard to see why particular business people, thinking only of the circumstances of their own business, see lower penalty rates leading to more sales, higher profits and, as a pleasant side-effect, more not-so-well-paid casual employees.

There would be some, of course, who looked no further than benefit of the lower wage rates they'd be paying even if they didn't bother opening their business for more days or longer hours than they are at present.

And, indeed, since they'd now be earning more than they were, that might be enough for some.

But let's assume the owners of the affected businesses really did want to open longer, sell more and profit more. Their fixed costs would now be spread over more sales, while their main variable cost – wages – would be lower per hour.

Question is: where would all these extra sales come from? From rivals that didn't bother opening on Sundays? That advantage isn't likely to last.

From businesses in other industries that now sold less during the week because their customers were seizing the opportunity to spend more on the weekend?

Of course, even if that were true it need be of no concern to any business person confident of being able to sell more. Their motive is to make more money and that's all a market economy expects of them.

But here's my point: just because some businesses can make more and employ more, this doesn't do much for the economy overall if their success comes at the expense of other businesses that make less and employ fewer.

When the advocates of lower penalty rates tell us that many extra jobs will be created, they're surely expecting us to take that as meaning more jobs overall, not just more jobs in some industries but fewer in others.

So let's switch to a macro or, as the commission likes to say, "economy-wide" perspective. We're told it will be great because, with more businesses open on the weekend, consumers will spend more and it's this extra spending that will create more jobs.

But how much the nation's consumers spend is ultimately constrained by their income. Are we expecting that consumers will spend more by saving less? Why would this be a good thing?

Why are we compelling employees to save 9.5 per cent of their wages if we really don't care about people saving much? (And don't mind being more reliant on foreign investment as a consequence.)

Maybe so as to spend more on weekend entertainment the nation's consumers might borrow more – on their credit cards or however. Would this be good for the economy? In any case, borrowing to boost your consumption is not something the nation's consumers can go on doing for long.

I don't believe there is much scope for us to be consuming a lot more than we are already – certainly not over the medium term. If so, then a lot of the businesses that sell more will be taking sales from other businesses.

And there's another possibility, one I suspect is quite likely: those businesses that open for longer on the weekend will sell more at the weekend, but less during the week.

To the extent that businesses achieve nothing more than spreading essentially the same amount of sales over longer opening hours – which I think is quite likely – they're likely to be worse off rather than better. The economy-wide benefits will be small, as will the net gain in employment.
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Saturday, August 8, 2015

It's official: the labour market is different

Any report that the hardline commentators brand as "mushy drivel" can't be all bad. And, indeed, the Productivity Commissions' draft report on the Workplace Relations Framework is far more enlightened, balanced and sensible than we've come to expect from that highly model-bound institution.

For several years, militant employer groups and the national dailies have been claiming that Julia Gillard's Fair Work Act reregulated the labour market, put the unions back on top and caused the slowdown in productivity improvement.

The report puts those people back in their box, rejecting outright their claim that the industrial relations system has become dysfunctional.

"Many features work well, especially given the need to find a balance between the conflicting goals of the parties involved," the commission's chairman, Peter Harris, said.

"Changes to the workplace relations framework have to recognise that it's not just about the economics. There are ethical and community norms about the way in which a country treats its employees."

The report's conclusion is that industrial relations needs "repair not replacement". So it does propose a lot of changes – most of which go the employers' way – which are worth debating, but not today. Today let's just record the full extent to which the scales have fallen from the commission's eyes.

Its first realisation is that the labour market isn't the same as other markets and labour is not just an ordinary input to the production process.

"Labour economists [those economists who specialise in studying the labour market] generally recognise that labour markets work somewhat differently from the pure competition model. Of course, no market aligns completely with the basic and tractable model described in introductory economic textbooks, and some of the common divergences from the competitive model arise in labour markets too," the report says.

"However, labour markets additionally have some particularly distinctive features. These features provide a potential economic rationale for different aspects of labour market regulation . . ."

What's distinctive about the labour market is that "units" of labour being added to the production process inescapably come with fallible humans attached. What's more, the human units work for fallible human managers. This makes the labour market far less impersonal than textbooks describe.

"In the real world, employers and employees are people with all their various flaws and virtues, and these can collide in workplaces in ways that have ramifications for how labour markets function."

For one thing, "people make mistakes". For instance, employers and employees may form an employment contract without doing enough to check the other side out.

For another, "employers and employees have values that are important to the way they do their work. An employee may want to work many additional hours at no cost because of professional pride. Employers may want to pay bonuses, provide better staff facilities or assist an employee facing family problems (say domestic abuse) because they are dealing with human beings who they wish to help and please.

"Employers and employees dealing with each other are not merely doing so as part of a calculated business strategy, and in some cases this opens the door for one party to exploit the other's goodwill and non-monetary motivations. (One less altruistic formulation of this is that employers may sometimes set higher prices for labour to motivate trust and to increase the cost of shirking – one example of so-called 'efficiency wages'.)"

The simple model assumes units of input and even units of output are homogeneous (all the same). But "there are few 'representative' employers and employees. People have heterogeneous [different] tastes for workplace conditions and heterogeneous abilities, even when paid the same wage rate.

"Some businesses are poorly managed, and most are not at the technological and managerial frontier [not best-practice]."

Some of these complexities "suggest a need for regulation, others not. For example, regulation of blatantly unfair dismissal is justified, not only because the act itself is problematic but also because the potential to do it allows leverage by an employer to exploit vulnerable employees".

The commission "considers that, on average, employers have stronger bargaining power than employees, with consequences for wages and conditions, unless countered by regulations or (constrained) employee collective bargaining".

Get that? The commission acknowledges the legitimacy of collective bargaining. It also accepts the relevance of ethical and social considerations.

"Labour market outcomes do not just affect economic performance – they also have a substantial impact on equality of opportunity, the stability of family relationships and social cohesion more generally.

"The ethical and social dimensions of the labour market form a basis for many aspects of the workplace relations system that differentiate it from the regulation of other markets. For example, the 'price' of labour differs from the price of most other inputs in an economy.

"A broad principle underpinning Australia's competition policy framework is that lower prices from competition are almost always desirable. In labour markets it is less clear that a lower price is necessary desirable, given that many people's incomes and wellbeing depend to a considerable extent on the price of labour and it can be costly to use alternative mechanisms to redistribute income.

"Indeed, the existence of a minimum wage – a 'floor price' set by regulation, which would usually be seen as contrary to the public interest for other goods and services – illustrates this distinction."

Returning to the commission's dismissal of the militant employers' claims, it finds that "contrary to perceptions, Australia's labour market performance and flexibility is relatively good by global standards, and many of the concerns that pervade historical arrangements have now abated.

"Strike activity is low, wages are responsive to economic downturns and there are multiple forms of employment arrangements that offer employees and employers flexible options for working."

But my favourite quote is this: "Toxic relationships between employers and employees can sometimes surface due to poor relationship management rather than flaws in the workplace relations framework."

Ain't that the truth.
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Wednesday, August 5, 2015

Digital disruption: more pros than cons

Do you get the feeling we've got a government that's worrying about everything except getting on with governing? One issue that's not getting the attention it deserves is the rise of "digital disruption".

The pace at which the continuing revolution in information and communications technology is reshaping industries and occupations is remarkable.

As the consultants Deloitte Access Economics wrote in a report for Google, just a few years ago most consumers logged on to the internet to access email, search the web and do some online shopping. Most of us still accessed the internet using a computer.

"Today, digital technology including cloud platforms, smart hand-held devices and social networks are the new beachheads of the sweeping impacts of the internet," the report says.

"Rapidly evolving from basic connectivity, these technologies are further changing not only how consumers interact with businesses, but also how businesses are organising themselves."

We've seen the digital revolution change the way we buy and listen to music, read books, learn the news, shop, do our banking, pay bills and check in on flights. Its changes to the news media and banking and other financial services have a long way to run yet.

The digital revolution is about information in all its forms, how it's gathered, processed, accessed, transferred and stored. "Big data" is about how all this information is analysed to produce further information about how we behave.

This is why you don't have to be very brave to predict that digital-driven change will be affecting many more industries before it's through.

As the consultants say, while reaching new customers and responding to customer needs is a big reason for businesses to go online and to use social media, we're now seeing "transformational change" inside businesses as they take advantage of the efficiencies that advances in digital technology are making possible.

This means "cloud, data analytics and machine-to-machine technologies" emerging as a second big driver of change. (It also means you and me learning to live with a lot of high-sounding words we barely understand.)

And phones are taking over the world. "The rise in mobile access to the internet and digital services through smartphones and connected devices [I think that means iPads] has prompted new ways of thinking about presenting information to consumers on smaller screens and capitalising on usage trends."

Read your newspaper on a phone? Sure. Many people already do, and we're working to improve our offering as we speak.

Hip business people speak of digital disruption as though it's a wonderful thing. It will make the world a better, faster, easier place, so bring it on.

But that word "disruption" sounds more nasty than nice. So which is it to be?

Both. If new inventions take hold and spread it's because enough people really do think they're an improvement.

But that doesn't stop the industries and businesses most affected by the advance from being turned on their head and maybe even forced to close. So the benefits to customers usually come at a cost to many workers.

Some are redeployed, some become redundant. Most ejected workers eventually find a new job – even if it isn't always as good as the one they left – though some, particularly older people, may never get back on their feet.

But how far have we got with the digital revolution to date? Deloitte Access Economics has gathered what we know and done some rough figuring in a report for the Australian Computer Society.

The consultants say that, compared with other developed countries, Australia is a high-level user and adopter of information and communications technology, with comparatively high rates of mobile broadband penetration and business adoption of digital technology for commercial practices.

According to the Organisation for Economic Co-operation and Development, for every 100 people in Oz there are about 114 subscriptions to mobile wireless broadband, more than any other country bar Finland.

Almost three-quarters of our businesses have a website and a very high 38 per cent of businesses actually make sales over the internet.

The OECD says our information technology specialists make up 3.6 per cent of our workforce, which puts us right behind the Nordic countries and North America. Using a broader definition, about 22 per cent of the workforce is in info-technology-intensive occupations.

The consultants' own estimates say about 300,000 info-tech workers are in the industry proper, with about another 300,000 in other professional and scientific service industries, public administration, financial services and various other industries. This amounts to 5 per cent of the workforce.

They estimate that the digital economy contributed almost $80 billion to gross domestic product in 2013-14, well up on their previous estimate in 2011 and about 5 per cent of the total economy.

But they identify two areas of weakness. First, the 10 per cent of our total annual spending on research and development that we devote to information and communications technology is way behind other developed economies, even small ones.

Second, demand for info-tech workers is expected to grow by 100,000 over the next six years, but Australian new graduates with info-tech qualifications have declined significantly since the early noughties.

More than 10,000 temporary skilled migrant 457 visas have been granted annually to info-tech workers in recent years. In 2013-14 it was closer to 20,000.

Really? This is the best we can do by our own young people? Surely we should be trying harder.
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Monday, August 3, 2015

Mainstream economics remains highly useful

When Gigi Foster gave a radical speech to the Economic Society in Sydney last week – which soon had the audience interjecting and arguing among itself – she was careful to begin by saying her goal was to add to the standard economic model, not replace it.

She claimed the economists' model was the most successful model in all of social science, then listed what she considered to be its four most useful contributions.

By rights I should be telling you about her radical additions to the model, but I'll save that for another day because I, too, have been known to be fairly full and frank about the model's weaknesses and, like her, I don't want anyone thinking that means I regard it as a load of bulldust.

Just the reverse, in fact. It's been so useful and so influential that most of its insights will strike you as bleeding obvious. They are now.

Dr Foster, an associate professor at the University of NSW, is one of Australia's leading behavioural economists. Along with Professor Paul Frijters​, of the University of Queensland, she's the author of the ground-breaking book, An Economic Theory of Greed, Love, Groups and Networks.

Her first "big hit" of conventional economics is its discovery that there are "gains from trade". And what's true within an economy – where we each specialise in producing something we're good at, then use money to trade with others – is equally true between economies.

It follows that countries preferring self-sufficiency to the interdependency of international trade will forgo much prosperity. One of economics' earliest discoveries is the benefit of "comparative advantage": countries do best when they concentrate on producing those things they can make at least opportunity cost relative to other countries' opportunity costs.

So you avoid erecting barriers to trade, follow your comparative advantage and import the rest from the cheapest suppliers.

Foster's second big win for economics is realisation of the benefits of competition – not just between producers but also between producers and their customers. So we prevent or regulate monopolies. We create markets when none exist – by, for instance, putting a price on carbon.

And we intervene in markets where we see that competition isn't sufficient to prevent them from failing to deliver the benefits we expect and where the intervention is likely to make the market work better.

Third, a natural role for governments is the provision of "public goods" – goods or services whose nature prevents private producers from capturing enough of the benefits to induce them to provide as much of the item as is in the community's interests.

Examples of public goods provided by governments are numerous: infrastructure, defence, education, the system of law and even the currency.

Foster's final example is the finding that monetary incentives matter. People respond to price changes – though their degree of responsiveness or "elasticity" varies under the influence of other factors. Taxation discourages economic activity, leading to a "deadweight loss" to the community.

That's Foster's list of insights we owe to economists and their model, but I can think of a few more. One is the aforementioned concept of opportunity cost. Because economic resources – including environmental assets – are limited, anything we choose to do comes at the cost of everything else we can't do with those resources.

Since these other things are endless, economists measure opportunity cost by looking only at the next most desirable thing we could have done. The moral of opportunity cost is: since you can't have everything, choose carefully.

Another insight is that anything we choose to do will bring costs as well as benefits. Moral: be sure to weigh the costs against the benefits before you jump.

Then there's our tendency to look only at the initial effect of particular developments. Economists know to ask the next question: but then what happens? It's usually the reaction to the initial effect – the "second-round effect" – that matters.

Say there's a big rise in the cost of electricity. The initial effect is to leave you with less money to spend on other things, which you hate. So you react to this by using power less wastefully, by buying a more energy-efficient fridge next time, or by investigating the costs and benefits of installing solar panels.

All this may seem obvious, but that's a measure of the economists' success in influencing the way we think.

Even so, it's surprising how often we forget these things. That's why we need economists as well as their model: to keep reminding us of the seemingly obvious and doing what they can to stop us wasting money.
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Saturday, August 1, 2015

Uni economics declines at hands of accountants

If you think economists have too much influence in the halls of power - or that Australia would be better off if its accountants and business people knew less about how the economy works - or that the political debate would be improved if fewer citizens were economically literate - I have good news: academically, the economists are being cut down to size.

And it's the accountants who are doing it.

While business and management courses and departments are booming, many universities are cutting back, even abandoning their teaching of economics. Faculties of economics are becoming business schools.

At the University of Sydney, the economists have been ejected from their own faculty and - along with the political economists - consigned to the outer darkness of the arts faculty (where, as it happens, they're getting more customers).

It may not be long before, to be able to study economics at uni, you'll need an ATAR (Australian tertiary admission rank) high enough to get into one of the "sandstone" universities, the Group of Eight (Go8): Australian National University, the universities of Sydney, Melbourne, Adelaide, Queensland and Western Australia, plus Monash and UNSW.

Trouble is, the sandstone unis don't rate as well on teaching as do the newer, smaller metropolitan and regional unis. Their top priority is research - and don't believe anyone who tells you researchers make the best teachers.

The story of the decline of academic economics in Australia has been told in several papers by Dr John Lodewijks, of the University of NSW, and Dr Tony Stokes and Dr Sarah Wright, of the Australian Catholic University.

At La Trobe University in Melbourne, the school of economics has had to greatly reduce its staff, with fewer professors. Its stand-alone economics degree is no longer offered. Similar changes began at the University of Western Sydney in 2012.

Victoria University's department of applied economics has been broken up, with staff now teaching finance and international business. Economics is being subsumed within business at the University of Newcastle, University of New England, University of Tasmania and James Cook University in far north Queensland.

Griffith uni on the Gold Coast has reduced its offering in economics. Edith Cowan uni in Perth has discontinued the economics major within its bachelor of business. Its economics teaching staff has been slashed, with most of those remaining now teaching finance and quantitative methods. Curtin uni in Perth has also got rid of many economists. Even at the uni of WA a bachelor of economics is no longer offered.

As with Sydney uni, at the multi-campus Australian Catholic University economics has  been ejected from the business faculty and transferred to arts.

When I did a commerce degree at the uni of Newcastle in the late 1960s, three years of economics were compulsory. These days in business courses it's down to one year - or less.

It's clear the accountants would like to be rid of economics completely. What holds them back is that their degree would lose accreditation with the professional accounting bodies.

Over the period from 2002 to 2011, Australia's total student load grew by 40 per cent. The economics students' load rose by just 28 per cent.

From 2012, but with transitional arrangements starting in 2010, universities' enrolments of domestic students were deregulated, meaning unis could enrol as many students as they liked and also that the federal government could no longer influence the number of students studying particular subjects. Enrolments became "demand determined".

The objective of this was to ensure a higher proportion of school-leavers went on to uni. So it has involved a general lowering of ATAR cut-offs for entry into particular courses.

Despite the growth in student numbers overall as a result of the uncapping of places, the number of students studying economics actually declined between 2008 and 2013.

The overall increase in domestic undergraduate commencements was 34 per cent. Business and management numbers rose 38 per cent, and marketing and sales courses rose 39 per cent. But economics commencements fell by 7 per cent to fewer than 5400.

Between 2007 and 2014, the average ATAR cut-off for "business/commerce" (which would include economics) at non-Go8 unis fell by 7.8 points to 65.1, while the average for the Go8 rose fractionally to 89.1.

It seems that the sandstone unis are now capturing more of the able students who formerly would have gone to the newer, lesser-status metropolitan and regional universities.

And it seems all this has allowed a turning away from economics. It's likely  the subject is perceived by students as more intellectually demanding, with less well-prepared students preferring business studies. Many people think business studies is more practical and more likely to lead to a job.

University managers want to shift resources to the subjects in greatest demand from students and probably think they're more likely to get funding from businesses.

So the teaching of economics is contracting and concentrating in the group-of-eight unis. But while these are well known for their high quality research, they're not particularly noted for high quality teaching of economics.

Research has shown a negative relationship between research quality and student satisfaction with teaching. And studies of course-experience questionnaires show that the elite unis perform worse in student satisfaction with teaching than the other unis, particularly the newest ones.

It was two of the lowest ATAR unis, Australian Catholic and Western Sydney, which achieved the highest scores - 86 and 80 respectively - in the good-teaching category.

It's easy to blame an intellectually lazy younger generation. But, to some extent, the academics have brought this on themselves.

There are plenty of hard subjects at uni, but for decades economists have taught economics as though it's only the cultivation of future PhDs that matters to them, making little attempt to capture young imaginations by demonstrating the practical relevance of their dry, ever-more mathematical theories.

Trouble is, it's not only they who'll pay the price of their neglect.
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Wednesday, July 29, 2015

BANKING AND FINANCE IN AN UNCERTAIN FUTURE

Talk to dinner guests of Hall & Wilcox, lawyers, in association with the Wheeler Centre, Melbourne - Wednesday, July 29, 2015 in Sydney & Tuesday, August 4, 2015 in Melbourne

I’ve been invited to talk to you about the future of banking and finance which, being a journalist, I’m more than happy to do. As a great newspaper owner from the Victorian era, Lord Northcliffe, once said, journalism is a profession whose business is to explain to others what it personally doesn’t understand. I know a fair bit about the economy, a fair bit about budgets and monetary policy and a fair bit about the news media, but I’m no expert on banking and finance, and I’m certainly no techhead.

In preparing for tonight I faced two choices: I could give you a gee-whiz job about all the radical, amazing, frighten changes that are about to engulf us, or I could give you the benefit of the views of grumpy, somewhat cynical old man who’s been watching banking and finance from the sidelines for 40 years and, in particular, watching the process of economic and social change over that time. You can’t be a commentator without being a student of change. I’ve decided to give you a bit of both, but less of the gee-whiz and more of the sceptical old fart.

But before I get into it, let me say this: it never ceases to amaze me that people never tire of asking economists - or, in my case, economic journalists - to tell them what will happen in the future. They keep doing this even though they know full well that economists are hopeless at forecasting. Why? Because as humans we’re addicted to the desire to know what the future holds so we can do something about it: stop it, sidestep it or exploit it. Psychologists call this humans’ “illusion of control”. We have an ingrained belief that if we can find out what’s coming up we can control what happens to us. It’s an illusion, of course. No one knows what the future holds and our ability to change it is usually a lot more limited than we imagine.

It’s because our desire to know and influence the future is a product of our evolution as a species that no amount of bum forecasts in the past deters us from asking for another forecast. So let me oblige. But rather than getting down to a few sexy, gee-whiz examples, I’m going to give you a more top-down, analytical view.

Around the world, and in Australia, banking and financial markets have been changing continuously since the early 1980s - that is, for about 40 years, because of the interrelated forces of globalisation (including the increased integration of the world’s financial markets), changing attitudes to regulation (first deregulation and now a degree of reregulation), and technological advance (particularly greatly reduced costs of telecommunication and of the collection, analysis, transfer and storage of information).

The practice of banking involves “intermediation” - taking deposits from savers and lending the money to investors - and “maturity transformation”: borrowing money for short periods or at call, but lending money for long periods of up to 25 years. Australia’s banking system, like most countries’, has long been dominated by a small number of very large banks, engaged in providing the full range of financial services: facilitating payments, taking deposits and making loans, providing investment advice and the management of assets, and actively participating in most financial markets, for short-term money, securities, foreign exchange, shares, derivatives and so forth. Why is banking so oligopolistic? Because of high barriers to entry arising from economies of scale and the high cost of information.

At this point the main sources of change in banking and finance are, first, continuing changes in the regulation of banks and other major financial players as governments and financial regulators seek to prevent another global financial crisis and, second, continuing innovation as entrepreneurs seek to exploit the opportunities and greatly reduced information costs created by the digital revolution.

The main question we’re considering - the main imponderable - is the extent to which changes in regulatory requirements and in information costs will reduce the barriers to entry, break down the banks’ dominance in the provision of financial services and lead to a flowering alternative suppliers of those services.

The international regulators’ efforts to raise the capital and liquidity requirements imposed on the world’s banks will reduce their gearing and thus, as they frequently complain, increase their costs of intermediation. Whether these greater costs will be borne by the banks’ shareholders or passed on to their customers will be determined by the strength of competition in the relevant markets. But, either way, the higher cost of intermediation will make the banks vulnerable to unregulated suppliers of financial services. As witnessed by the growth of Australia’s corporate bond market, our big corporates are already borrowing directly from the market rather than from banks, and this practice is likely to move down to medium-sized corporates.

Of course, to the extent that the costs of tighter capital requirements shift transactions from the regulated to the unregulated sector, it will frustrate the regulators’ efforts to reduce the risk of another financial crisis. But don’t underestimate the regulators’ ability to fight back by using the digital revolution’s huge reduction in the cost of gathering and analysing financial information to impose much greater disclosure of transactions of non-banks as well as banks (see the speech by Andrew Haldane and others at the Bank of England, in March 2012).

At last we’re up to the sexy bit: all the amazing new products, and opportunities and new players that are likely to emerge as digital disruption reaches banking and financial services. As a journo I do know something about the way the digital revolution is hugely disrupting one industry after another, changing their face for ever. Whatever scepticism you may hear from me, be clear on this: I don’t for a moment doubt that major digital innovation is coming to banking and financial services.

For a full list of every presently conceivable innovation that may possibly disrupt banking as we know it, I refer you to the report on The Future of Financial Services, prepared by Deloitte and others for the World Economic Forum in June this year. But picking out the highlights, in payments system category we have mobile money and digital wallets, such as Apple Pay and Google wallet. This will continue the reduction in the use of cheques and cash, increasing the efficiency of the payments system to the benefit of all, but without much disruption to the banks. We can perhaps reduce the involvement of banks in the making of payments, but I don’t see how we can get away from holding our money in banks. If so, there’ll be a bank somewhere at either end of the payment, even if the transfer isn’t actually conducted by a bank.

Of course, we could keep our money in “crypto currencies” such as bitcoin, but so far the only people doing so seem to be crooks and a few geeks who love trying anything new. If you go back far enough you find we have a history of non-government money - of banks issuing their own banknotes - and it wasn’t a happy one, hence the ultimate outlawing of private money. Apart from any risk benefits from a government monopoly over the issue of fiat money, remember that governments and their central banks benefit greatly from seigniorage.

Turning from payments to intermediation, we come to peer-to-peer lending. The main point here, I think, is that you don’t need to be a bank to match a person or company wanting to lend a certain sum for six months or five years with a person or company wanting to borrow that sum for the same period. Nor do you have to be a bank to assess borrowers’ credit worthiness using advanced software. But matching is not intermediation; it’s not standing between the depositor and the borrower so that the depositor’s claim is against a big, regulated, virtually government-guaranteed bank, not against some puny borrower. Similarly, matching is not maturity transformation; it’s not using a thousand at-call deposits to issue one 20-year loan. Both intermediation and maturity transformation involve taking risks. If a digital upstart doesn’t take on those risks there wouldn’t be many people wanting to lend through them rather than a bank. Certainly, not after the first time the economy had turned down and caused many borrowers to be unable to repay their debts. Were the digital upstart to take on those risks it would either have to lay them off to a bank, or with help from a bank, or it would itself become a virtual bank - in which case it wouldn’t be long before the bank regulators began regulating it.

Turning from intermediation to investment management, much of which is done today by bank subsidiaries, it’s not hard to see that digital upstarts could have success in offering automated, and hence cheaper, advisory functions and actual asset management. But one question is how many punters - or even businesses - would be happy to hand their savings over to a financial robot rather than a human with a good bedside manner.

Summing up, it’s clear that digitisation gives new entrants to the financial services industry the potential to greatly reduce the costs of gathering, processing and transferring financial information. They also have the potential to create valuable new information from the analysis of that financial information. And they have the advantage of having no legacy assets or attitudes.

By the same token, incumbency also carries some advantages. The banks have deep pockets to match the upstarts on the digitisation of financial information or to buy out or copy innovators that succeed with new tricks. And they have a record of being early adopters of improved technology.

But banking is very different from news or books or records or shopping for sneakers. Banking is much more about managing of various forms of risk. And to me the key question is whether digital innovation offers any great advance in the management of risk in addition to its advantages in the management of information. If it doesn’t, I doubt if it will get far. If it does, the banks really will be given a run for their money. But remember that the regulators’ primary concern is systemic risk - the ability of failures in the banking system to inflict great damage on the rest of the economy. So if the digital upstarts do become bank-like - the banks you have when you’re not having banks - I don’t imagine the authorities would waste too much time in starting to regulate them as banks. Bill Gate’s famous saying that “we need banking but we don’t need banks” is a non-sequitur. Any rival outfit that steals the banks’ core business itself becomes a bank.

Now, at last, we come to the part where the grumpy old man comes out of his cave. People have been predicting the demise of the big banks since the advent of financial deregulation in the 1980s - so far to no avail. Can you remember when the entry of the foreign banks was going to do in our local banks? Can you remember when deregulation and the emergence of superior specialised rivals in the provision of particular financial services was going to dismember our big universal-provider banks? So far, whatever the challenge, our big four have gone from strength to strength. Moral: don’t write them off too cheaply.

Next, if you want advice on what the future holds for banking and finance, my advice is that you’ll do better talking to economic historians and the students of earlier waves of major technological innovation - from the railways to electricity to the internal combustion engine to radio - than listening to futurologists and tech-heads. One thing the students of economic history will tell you is that it can take decades for the full commercial potential of major advances to be uncovered and implemented. Another is that the hundred or more start-ups determined to make a killing out of producing automobiles (or whatever) will eventually pack down to just a handful of big, successful, long-lasting corporations - GM, Ford and Chrysler - but until the end it’s impossible to predict who the victors will be.

Even in terms of which gee-whiz new ideas will survive and prosper, and which won’t, the futurologists have a list of failed predictions as long as your arm. They impress us because they seem to know so much about the new technological wonders just over the horizon, but this is their downfall: they love the technological and they love novelty. What they don’t know much about is human nature. Consequently they fail to make the key distinction between what new technology could do for us and what we’ll want it to do for us. Only the stuff we want - the stuff that fits in with human nature - will survive and prosper. Consider the lack of interest in telecommuting. Or the continuing concentration of the financial markets despite the move to electronic trading. Predictors must never forget that humans are intensely social animals. We like to be with others. Urban economists studying the increasing concentration of GDP - value-adding - in CBDs are realising that we learn from being in contact with others. It seems conference calls, even Skype, are a poor substitute for face-to-face contact. MOOC - massive open online courses.

Next, what drives technological change is competition and the desire for profits; business outsiders trying to steal a march on the incumbents, or insiders on their fellow incumbents. I remember Bob Gottliebsen before the Tech Wreck banging on about the huge profits to be made from B2B. But if you study the major technological advances of the past you soon realise that what starts as business people out to make a killing ends up delivering its greatest benefit to customers. The way it works is that any player who comes up with a really successful innovation will soon be copied - by other outsiders and, eventually, by the incumbents- which forces down prices and profits, and shifts the benefit to customers. Apart from any history, I know this from the digital disruption of classified advertising in newspapers. The users of classified ads for houses, jobs and cars have ended up with an infinitely better product for a fraction of the price of an old newspaper classified.

This process by which well-functioning market economies deliver the benefits of digital disruption and other technological change to customers rather than capitalists is one of the great attractions of capitalism. Which is why, though I’m uncertain how much digital disruption will do knock the banks off their perch, I am confident the new or improved products we end up with will be of great benefit to the users of financial services.


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Job insecurity isn't as great as you imagine

As everyone knows, the world of work just gets tougher. For a start there's the ever-growing incidence of "precarious employment" – people in casual jobs, or on short-term contracts, or working for labour-hire companies or temping agencies, or being cast adrift by their employer without benefits as supposedly self-employed.

If you do have one of the ever-scarcer full-time, permanent jobs, you're probably working a lot longer hours than you used to. Unpaid, I'll be bound.

These days, no one stays in the same job – even the same occupation – for very long. More and more people are being made redundant. A young person leaving education can expect to have many different jobs before finally they retire at 70.

It won't be long before many people don't so much have a job as a portfolio of jobs – different things they do for different outfits in any week or month, hoping that when they add it all together it amounts to a reasonable living.

All pretty terrible, eh? There's just one problem – it might be what everyone knows, but none of it's true.

Two profs at the University of Melbourne's Melbourne Institute, Roger Wilkins and Mark Wooden, have looked at the figures and they question all we think we know. Their findings were published in the Australian Economic Review.

It is true we have a lot of part-time and casual employment in Australia – more than in most other rich countries – much of it done by mothers with young families and students who aren't wanting a full-time job. And, these days, by people in semi-retirement.

It's also true that the number of part-time and casual jobs grew rapidly for several decades. It's still growing, but much more slowly.

According to the authors' reading of the figures, over the 10 years to 2013 the proportion of men working part-time has increased by 2 percentage points to just under 18 per cent, while the portion of women has been steady at almost 48 per cent.

While most part-timers are also casuals, the two groups don't overlap completely. The Bureau of Statistics defines casual employment as not receiving paid annual leave and sick leave. Its figures show that, for men, the proportion of casuals has been relatively steady since the late 1990s, fluctuating about 20 per cent. Among women the share has fallen from about 31 per cent to less than 27 per cent.

The annual household, income and labour dynamics in Australia – HILDA – survey shows that more than two-thirds of workers were in permanent or ongoing employment in 2012, an increase of 1.5 percentage points since 2001, when the survey began.

HILDA suggests the share of labour-hire and temporary-employment agency jobs has fallen over that time from 3.7 per cent to 2.7 per cent. (It would be much higher than that in particular industries, of course.)

Nor can Wilkins and Wooden find any evidence that there's been a shift away from employment to greater use of self-employment. Indeed, the stats bureau's figures show the proportion of self-employed in the workforce has been steadily declining over the past 20 years, from 14 per cent to 10 per cent in 2013.

Turning to overwork, there was a time when it was increasing (which got a lot of media publicity), but since then it's been declining (which has got little).

Among men working full-time, the proportion working no more than 40 hours a week increased from 52 per cent to 58 per cent over the 10 years to 2013. The proportion working more than 50 hours fell from 31 per cent to 27 per cent.

That's still a lot, of course. But remember that the people you'd most expect to be working long hours are managers and highly skilled professionals, and these have long been the two fastest-growing occupations. Such people rarely get paid overtime. Rather, the long hours they work are reflected in their hefty annual salaries.

Then there's the widespread perception that these days people are always losing their jobs and having to move on. When employers announce mass layoffs it invariably gets much attention from the media. When there's nothing to announce it gets no attention.

The stats bureau's figures for average job duration and rates of job mobility show little sign that jobs have become less stable, the authors say. In February 2013, just 18 per cent of the employed had been in their job for less than a year, down from 22 per cent in 1994.

In the latest figures, just over one worker in four had been in their job for at least 10 years, up from 23.6 per cent in 1994.

Of course, how long people stay in the same jobs is determined by both dismissals and quits. If jobs are becoming less secure you'd expect dismissals to be up and voluntary departures down.

Both of these vary with the ups and downs of the business cycle but, even so, they've tended to decline. In February 2013, fewer than 3 per cent of all the people who'd had a job in the previous 12 months had been retrenched.

The proportion losing their jobs for any reason was 6 per cent. About 10 per cent of people had quit their jobs.

There are a lot of problems in the world, including the world of work, but let's not imagine more than actually exist.
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Monday, July 27, 2015

Why the economy's slow growth may last

The biggest economic story last week wasn't all the wishful thinking about raising the goods and services tax, it was Reserve Bank governor Glenn Stevens' warning that the economy's "potential" rate of growth may be lower than we've assumed.

Predictably, those commentators who did see the significance of this news were too busy putting their own spin on it to make sure what Stevens' said was widely taken in. So let me have a go.

The macro managers' long-standing belief that the economy's "trend" rate of growth is 3 per cent a year or a fraction more has been challenged by the Bureau of Statistics' labour force estimates showing that, over the past year, the rate of unemployment has stabilised at 6 per cent.

Trouble is, the latest national accounts show the economy growing by only 2.3 per cent over the year to March. This is well below the trend rate that, almost by definition, is the rate at which the economy must grow to hold the unemployment rate steady.

How is this discrepancy explained? Stevens ran through the range of possibilities. Maybe employment hasn't been growing as strongly as the figures say at present. Maybe the economy has been growing more strongly than the figures say at present.

Or maybe part of the surprisingly strong growth in employment is explained by the unusually slow growth in wage rates, which would be saving some jobs and creating others.

The final possibility – and the one to which Stevens gives most weight – is that the trend rate of growth is lower than we've assumed, thus allowing unemployment to stabilise at a lower rate of economic growth than we've assumed.

Economists use the term "trend" in both a backward-looking and a forward-looking sense. If you calculate our average actual rate of growth over the past 10 or 20 years, this must have been our "potential" growth during that period.

If nothing in the economy has changed over that time, it should also be our average, trend rate of growth in the coming five or 10 years.

However, things do change – the population ages, for instance – so economists have to make guesses about what our potential growth rate will be in the future.

Our potential growth rate is the maximum rate at which the economy can grow on average over the medium term without a causing a serious inflation problem. It's set by the economy's supply side.

It represents the average rate at which the economy's capacity to produce goods and services is growing. And this is usually thought of as being determined by the rate of growth in the working population plus the rate of improvement in the productivity of labour.

(Whether in any particular year the economy is growing at a rate below, at or above its potential growth rate is determined by the strength of demand at the time. However, the economy can grow faster than its potential "speed limit" only for as long as it has idle production capacity to use up.)

But this is where those commentators who cottoned on to the significance of Stevens' views jumped to their own conclusions about what was causing the suspected slowdown in potential growth. They assumed it must be caused by a slowdown in labour productivity improvement.

Why? Because this fits well with the economists' (including Stevens') long-running campaign to persuade us to undertake more micro-economic​ reform so as to raise productivity and, hence, material living standards.

What they missed in their missionary zeal was Stevens' clear indication that he thought the culprit was slower-than-expected population growth.

The econocrats' figuring suggest a potential growth rate of 3 per cent would be explained by population growth of 1.7 per cent to 1.8 per cent a year, plus growth in labour productivity of 1.2 per cent to 1.3 per cent a year.

So their expected rate of productivity improvement is already pretty low, while the end of the mining construction boom and slow growth generally have seen population growth slow to 1.5 per cent a year or less as the net intake of workers on temporary 457 visas falls and Kiwis go home to a faster-growing economy.

The other thing the missionaries missed was Stevens point that, to the extent the lower trend rate is caused by lower population growth, it shouldn't involve any slower rate of improvement in our material living standards, as measured by growth per person.

Missionary micro-economic reformers won't win lasting converts by misrepresenting our present position, nor the outlook for growth. Their pessimism about future productivity improvement isn't supported by our more recent performance. It's little more than a guess.
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Saturday, July 25, 2015

We're not doing too badly on productivity

Rummaging through the media's rubbish bins this week, I happened upon some good news. According to the Productivity Commission's annual update, the productivity of labour improved by 1.4 per cent in 2013-14.

And get this: in the 12-industry "market sector" of the economy, it improved by 2.5 per cent in that year and by 3.7 per cent the year before.

To give you an idea, the 40-year average rate of market-sector productivity improvement is 2.3 per cent. So, despite all the worrying we've been doing in recent years about our poor productivity performance, it seems we're now doing quite well.

In which case, how come no one wanted to tell us? I can think of three reasons. First is the media's assumption that good news is of little interest to their customers.

Second is that the Productivity Commission's preference is for brushing aside the labour productivity figures and getting us to focus on the figures for "multi-factor productivity", which show an improvement of just 0.4 per cent in 2013-14 and 0.4 per cent the year before. This compares with the 40-year average of 0.8 per cent a year.

Third is that the nation's economists are engaged in a campaign to persuade us we need a lot more micro-economic reform so as to raise our rate of productivity improvement and, hence, the rate at which our material standard of living is rising.

They'd make the same argument whether our productivity performance was good, bad or indifferent, but it helps the selling job if they leave us with the impression our recent performance is poor.

Anyway, let's take a closer look at the commission's new figures. Productivity, which compares the growth in the output of goods and services with the growth in inputs of labour and capital, is a measure of the efficiency of our production. When outputs grow faster than inputs, the economy – the economic machine, so to speak – has become more efficient.

The simplest (and probably least inaccurate) way of measuring productivity is to take the increase in the quantity of goods and services produced during the year and divide it by the increase in the total number of hours worked to produce the stuff.

The main way to increase the productivity of workers is to give them more machines to work with. But the commission believes a more revealing measure is multi-factor productivity. You calculate this by dividing the increase in output by the increase in labour inputs plus the increase in capital inputs (use of machines and other equipment).

The main thing causing an increase in multi-factor productivity is technological advance – the invention of better machines plus improved ways of running businesses. But also improvements in "human capital" – the rising education and skill of the workforce.

That's all fine in theory, but it gets pretty ropey in practice. For a start, we have no way of measuring the productivity of the public sector (healthcare, education and public administration) because, for the most part, it doesn't sell its output in the market.

The market sector covers the financial services, mining, construction, manufacturing, transport, retail trade, wholesale trade, information media and telecommunications, electricity gas and water, agriculture, accommodation and food services, arts and recreation services, rental hiring and real estate services, professional scientific services, administrative support services, and "other" services industries.

That's 16 industries – though, for reasons it doesn't explain, the commission's 12-industry measure of market sector productivity doesn't include the last four industries on that list. Even so, the 12 industries account for 65 per cent of gross domestic product.

A much more serious problem is that the measurement of multi-factor productivity is quite dodgy. It's measured as a residual, meaning that any error in measuring the three other items in the sum will (and does) make the measurement of multi-factor productivity wrong.

More particularly, economists have no way of accurately measuring capital inputs. Just one of their problems is that they can't distinguish between more machines and better machines, meaning their so-called measure of multi-factor productivity excludes much of the technological advance it purports to measure.

The besetting sin of economists is the way they confidently quote their figures to a trusting public, without breathing a word about the data deficiencies and dubious assumptions that lie behind their calculations. When they fail to issue a product warning, it's the duty of the conscientious economic journalist to call them out.

In such circumstances, the commission's results need to be treated with scepticism – particular when, as was true in the noughties, they were so unprecedentedly low as to be implausible.

But let's look at the commission's breakdown of the latest year's supposedly weak result of 0.4 per cent. Half of the 12 industries – all of them in the services sector – achieved remarkably strong improvements, ranging between 1.1 per cent and 5.4 per cent.

Three industries – mining, construction, agriculture – had growing production but marginally declining multi-factor productivity. We know the problems in mining and construction are temporary. Agriculture's poor performance came mainly from drought.

The last three industries – utilities, manufacturing and transport – suffered declining production but lesser declines in inputs, meaning their multi-factor productivity deteriorated quite significantly.

We know the utilities, particularly electricity and gas, are coping with major structural changes, not helped by the earlier misregulation of poles and wires. We know manufacturing is still recovering from the high exchange rate caused by the resources boom. Whatever transport's problem is – we're not told – it will get over it.

That's the trouble with the supposedly worrying figures for multi-factor productivity. Apart from the ropiness of their calculation, when you investigate the stories for the particular industries involved you can't find anything major to worry about.

I'd say that, despite all the barrow-pushers wanting to use poor productivity figures to bolster whatever cause they're promoting, we're not doing too badly on productivity.
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Wednesday, July 22, 2015

Everyone wants a slice of a higher GST

Norman Lindsay called it the Magic Pudding. Economists call it opportunity cost. In the untiring campaign by some for an increase in the goods and services tax, a new magic pudding has been created. The trouble is, opportunity cost is real, but magic puddings aren't.

Put at its simplest, the concept of opportunity cost says that if you've got a dollar, you can only spend it once. This truth might be glaringly apparent, but it's surprising how often grown men (and, less commonly, grown women) forget it.

By contrast, the original magic pudding allowed its owners to "cut and come again". No matter how many times they cut themselves a slice, the pudding would magically grow back.

Just the most recent proposal for a higher GST – of 15 per cent – comes from the Premier of NSW, Mike Baird. He wants it to help the state governments raise more taxation to help them pay for the ever-growing cost of their public hospitals and still balance their budgets.

But Baird and some of his fellow premiers aren't the only people with designs on the extra revenue a higher GST would bring. He's been spurred by the knowledge that, so far, Prime Minister Tony Abbott is sticking with the plan announced in last year's budget to move to a less generous way of indexing federal grants to the states for their public hospitals and schools from 2017, which would cause those grants to grow by $80 billion less than they would have, over the following decade.

There are people cynical enough to believe this cut was aimed at softening the premiers up and obliging them to agree to an increase in the GST as the only solution to their future funding problems.

But do you see what this means? It means a big slug of the extra revenue raised by a higher GST would go towards solving the feds' budget problems, not the states'. Suddenly, the pot of gold isn't looking so big.

But that's not all. There are a lot of economists and business people urging that the proceeds from the higher GST first be used to abolish various state taxes regarded as "inefficient" – that is, ones that have the effect of seriously distorting the choices people make.

Top of the list of inefficient state taxes is stamp duty on the transfer of commercial and domestic properties, and the tax on insurance policies. But some business people have their eye on using the GST to replace payroll tax. And a lot of landlords would like to get rid of land tax.

But why stop at eliminating state taxes? Why not use it to reduce a few federal taxes you don't like?

Big business is very anxious to "reform" the tax system by using a higher GST to cut the rate of company tax. And many high income-earners believe it vitally important to cut the top personal tax rate, lest all our top people migrate to countries where taxes are lower (Malaysia, say).

It's clear Treasurer Joe Hockey would very much like to cut company tax and the top tax rate for individuals, if only the boss could summon the courage (and Hockey's powers as a salesman were magically transformed).

But Hockey has another problem he'd no doubt like the GST's help with. He knows that the main thing he's using to allow him to project slowly declining budget deficits in coming years is ever-rising collections of income tax, caused mainly by "bracket creep" – inflation pushing people into higher tax brackets.

The trouble is, after a while, people notice the higher tax rate they're paying on any overtime or pay rise. When they do, they tend to get pretty stirred up and look for a politician to blame.

So Hockey knows that, before long, he'll need to have a tax cut that gets people on tax rates below the top one back into lower brackets. It would be nice if he could make up some of this lost revenue by increasing the GST.

See the magic pudding? There's a host of different groups pushing for higher GST, but they all want to use the proceeds to pay for something different. Between them they have plans to spend each extra GST dollar many times over.

That's true even if, as well as simply increasing the rate to, say, 15 per cent, we also extended it to cover food, education, health and financial services.

And don't forget this: because the GST is universally acknowledged to be a "regressive" tax – it takes a higher proportion of low incomes than of high incomes – it would have to come with a lot of "compensation" for low- to middle-income earners, in the form of increases in pensions and the family allowance and cuts in income tax at the bottom.

All this compensation would have a cost. In other words, the net proceeds from raising the GST would be a lot lower than the gross.

If you get the feeling the debate about increasing the GST has entered the realm of fantasy, you're not wrong. Once the more fanciful ways of using the proceeds had been eliminated, the number of people pushing for it would be greatly reduced.

If you get the feeling this means the GST won't be going up any time soon, you're not wrong, either. I won't be losing any sleep over it.
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