Saturday, November 14, 2015

Go to ex-bureaucrats' blogs for the good oil on policy

Dr Ken Henry, a former Treasury secretary, says he can't recall a time when the debate about public policies has been poorer. I can't either, and I guess the dreaded MSM - mainstream media - is part of the problem.

But if the challenge of digital disruption has tempted the mainstream to devote more time to political colour and movement and less to debating government policies, there's one respect in which the internet has made things better.

The advent of blogging has given anyone who wants to the ability to air their thoughts to the world. A lot of blogs come under the heading of you're-entitled-to-your-opinion, but sometimes they're written by people who know a lot more about the topic than most of us and have a valuable contribution to make.

That's particularly true when academics take to blogging. One of the earliest bloggers about economic policy  was Professor John Quiggin, of Queensland University. Other high quality Australian blogsites are Club Troppo, Core Economics and, for the more libertarian, Catallaxy Files. (There was a blog called Ross Gittins, Corrected but they seem to have given up.)

The best academic blogsite is undoubtedly the uni-sponsored The Conversation. To have all those academics writing short, timely, readable pieces in their area of specialty is an invaluable contribution to the policy debate.

And then there's the blog of the former bureaucrat John Menadue, called Pearls and Irritations. Menadue brings in other contributors, and his blog is the place to go to see ex-bureaucrats casting a critical eye over present government policy.

These guys know where the bodies are buried, and no one sees through the political smoke and mirrors  more easily than they do.

Earlier this year Menadue teamed up with the former econocrat Dr Mike Keating to instigate a special series on the many challenges facing the government today, called Fairness, Opportunity and Security, with a wide range of contributions from ex-bureaucrats (including Stephen Fitzgerald, David Charles, Andrew Podger and Jon Stanford), academics (including Michael Wesley, Ian Marsh, Ian McAuley and Julianne Schultz) and academics who've spent time in government (including Ross Garnaut, Glenn Withers and Stuart Harris).

Now Menadue and Keating have turned the series into a book of the same name, published by AFT Press, which they asked me to launch last week. It covers 13 topics ranging from the role of government to the economy, foreign policy, health, the environment and Indigenous affairs.

In his discussion of the way vested interests seem to have excessive influence over policymaking, Menadue notes the remarkable rise of the lobbying industry, estimating there are now more than 1000 lobbyists operating in Canberra.

"The health 'debate' is really between the minister and the Australian Medical Association, the Australian Pharmacy Guild, Medicines Australia and the private health insurance companies," he writes.

"The debate is not with the public about health policy and strategy; it is about how the minister and the department manage the vested interests."

Menadue says much of the policy skills in Canberra departments have been downgraded and policy work is contracted out to accounting and consultancy firms. Policy work within the government is now undertaken more in specialist organisation such as the Productivity Commission.

"Departmental policy capability has been seriously eroded. That is the real story behind the problems of the pink batts scheme."

As for the "inexperienced and young ministerial staffers", they're "much more likely to listen to vested interests".

On foreign affairs and internal security, the blog collection says we've become overdependent on the United States at the expense of our relations in our region. As Paul Keating once said, we should be "finding our security in, not from, Asia".

In dealing with the threat from terrorism, "a balance needs to be struck between national security and the freedoms essential for a civil society, including the humane treatment of refugees. The politicisation of security has arguably made us less safe."

On Medicare we're told it "has stood the test of time but it now represents the single biggest budgetary challenge and it is over 30 years since it has been seriously reviewed and reformed".

On superannuation, Andrew Podger, former head of various government departments and now a professor at the Australian National University's Crawford School of Public Policy, makes a plea for considered and balanced reform rather than piecemeal tinkering.

You'll go a long way before you find someone providing a more authoritative, independent and sensible commentary on budget repair and other fiscal matters than Mike Keating, former head of the Finance department and Prime Minister's and Cabinet.

In this book he has hardheaded things to say about the dream of lower taxation, which "has been embraced by all political parties without any evidence that, given our already low starting point, less taxation will in fact lead to higher economic growth, let alone pay for itself".

He quotes John Howard saying that tax cuts should be considered only "after you have met all the necessary and socially desirable expenditures".

All the evidence is that these spending demands, even if efficiently funded, are most unlikely to be fiscally sustainable without a modest increase in taxation relative to gross domestic product.

"Indeed, Australia already has lower taxation than almost any other advanced nation, but we aim to provide the same level of public services and welfare as the others," he writes.

"Thus the biggest challenge facing modern governments is the gap between expectations on them and their capacity to deliver.

"In these circumstances, encouraging unrealistic expectations of tax cuts is only making government more difficult."

Reading this collection of blogs leaves you with the impression the good bureaucratic advice our successive governments have needed to do a better job of running the country now resides outside the public service, in the minds of the retired bureaucrats who're from the days when they were expected to know about policy.

Wednesday, November 11, 2015

We can grow GDP if we stop growing natural resource use

Some things are more important even than the fate of the goods and services tax. A question I regard as just a tiny bit more significant to our future is whether we can continue increasing our population and material standard of living without doing irreparable damage to the natural environment.

Few of us noticed in all the excitement over tax reform, but last week we made a big step forward in answering this question. The CSIRO unveiled the results of a ground-breaking, two-year project – the Australian National Outlook report – in which it integrated a model of the economy with no less than eight models of different aspects of the global and domestic natural environment in which the economy exists.

So, is ecologically sustainable growth possible? Is it possible to "decouple" continuing economic growth from continuing environmental vandalism?

It depends on what you mean by "growth". There's enormous confusion on this point because what economists take the word to mean is not what scientists take it to mean.

What scientists mean by growth is growth in the "throughput" of natural materials and energy – using those resources to generate economic activity and, in the process, turning them into various forms of pollution and other waste.

They point out that such growth simply cannot continue indefinitely because the natural world – the global ecosystem – is of fixed size. And they have to be right because they're merely stating the first law of thermodynamics.

But that's not what economists mean by growth. They mean an increase in gross domestic product, most of which is cause by increased productivity (efficiency). It may or may not involve an increase in the economy's throughput of natural resources.

So what does the CSIRO's modelling say about whether we can continue to grow without inflicting further damage on the environment?

It says GDP can continue growing strongly, but throughput of natural resources can't. So the people who want continued growth in GDP win, but so do those saying ever-increasing use of natural resources must stop.

Since no one knows the future, CSIRO's economists and scientists ran through their super model 18 different scenarios covering different rates of growth in the global population, different degrees of global action to restrain climate change and a range of differing development in Australia and its economy.

All 18 scenarios project continuing strong growth in Australia's population and GDP out to 2050. But get this: only three of those scenarios also saw improvement or no further deterioration on the model's three key indicators of environmental health: emissions of greenhouse gases, water stress, and loss of native habitat.

As well, two of the three scenarios see no increase in the economy's annual throughput of natural resources, while the third projects a fall in material throughput of 38 per cent.

All this says ecologically sustainable growth and decoupling do seem to be possible, provided the world gets its act together.

The good news is that the model's results don't rely on "technological optimism" (don't worry, market forces will call forth a technological solution to every problem before the proverbial hits the fan) but nor do they require that we renounce our materialist ways and become greenie vegan mud-brick makers.

We don't need to do anything we don't already know how to do and, in many cases, have already begun doing. We just need to do a mighty lot more of it.

The bad news is that we can't do it on our own. To achieve improvement in the key environmental indicators and a fall in material throughput we need effective international action to limit the world's population to 8 billion in 2050 and limit global warming to 2 degrees in 2100.

This would require "very strong" global and Australian effort to reduce greenhouse emissions.

The two other environmentally not-so-bad scenarios – involving world population growing well beyond 8 billion and global warming limited to 3 degrees – would require "strong" global and Australian effort to reduce emissions.

Strong translates as a worldwide price per tonne of carbon dioxide emissions of $US30 ($42) in today's dollars; very strong translates as $US50 a tonne.

These world prices would be applied in Australia. But we'd have a comparative advantage over many countries that would reduce the carbon price's adverse effects on our economy: we could achieve up to half our required reduction in net emissions by "carbon sequestration" – reforestation of cleared land, either with one species of eucalypt (to maximise sequestration) or a range of eucalypts (to also restore native habitat).

At these carbon prices, our farmers could earn up to five times what they make from using the land to produce beef.

Our greenhouse emissions per person would fall from five times the global average in 1990 to below average by 2050.

Our biggest problem would be avoiding water stress, particularly because reforestation would add to the problem. The price of water for agriculture would be a lot higher and, in the cities, we'd have to do a lot more desalination and water recycling for industrial use.

I don't regard this as the last word on the subject. All modelling is far from infallible and this exercise is no different. The good thing is that a last we've made a start at reconciling our materialist ambitions with the constraints imposed by the natural environment we hope to continue living in.

Monday, November 9, 2015

Tax reformers forget budget repair

Don't say no one warned you. As finally the nation focuses on tax reform, something is quietly slipping out of our grasp: the return to a balanced budget.

How so? Short answer: an annoying little thing called opportunity cost. Long answer: tax reform and budget repair are, to a significant extent, in conflict. The more we get of one, the less we get of the other.

So which does the government, its big business urgers and most economists want more? The choice will be most excruciating for Treasury.

The first reason for doubting we'll ever see a return to structural budget balance starts with simple arithmetic. For tax reform to have no direct effect on repair of the budget, the total reform package needs to be "budget neutral": its net changes on the revenue side should exactly offset its net changes on the spending side.

But major, potentially unpopular tax reform doesn't work that way. In practice, governments need to minimise the number of net losers by giving away more than they take.

John Howard's package introducing the goods and services tax in 2000, for instance, was heavily budget negative. He'd taken the precaution of saving up, so to speak, to pay for disproportionate tax cuts by amassing huge bracket creep, having avoided tax cuts for five or six years.

Of course, he had the budget well back into surplus by then and could take the hit without causing concern.

Nothing about Malcolm Turnbull's rhetoric suggests he's headed for a budget neutral package. He's been assuring his right wing that the package won't involve any net increase in the overall tax take.

But if it's revenue neutral rather than revenue positive, that means it has to be budget negative.

Why? Because the package will need to compensate low-income earners via increased spending on pensions, the dole and family allowances.

And if the premiers aren't to oppose the reform package, the feds will need to pay a fair proportion of the GST proceeds to the states. This would represent a decrease in Tony Abbott's $80 billion in prospective budget savings from cuts to the states' grants for schools and hospitals, already in the budget's forward estimates.

The second reason for doubting the budget will ever be repaired is that much of the present deficit is structural rather than cyclical. Turnbull has been saying the budget will return to surplus once the economy gets back to trend growth.

Sorry, Malcolm, not right. By definition, to say we have a structural deficit – as Treasury does in each year's budget papers – is to say the budget will still be in deficit even when we've returned to the normal part of the business cycle.

Structural deficits are the cumulative effect of past unfunded decisions to cut taxes or increase spending. This may not have been obvious at the time if the economy happened to be booming, giving you a big cyclical surplus to hide your transgressions.

This is why so much of our present structural deficit is owed to the decisions made by the Howard government during the first stage of the resources boom, including the eight successive tax cuts and, notably, Peter Costello's unsustainably generous increase in superannuation tax concessions in 2007. Also, Howard's halving of capital gains tax in 1999 (which has done so much to fuel negative gearing).

Labor's unfunded spending on the national disability insurance scheme and the Gonski school funding reforms have added to the structural problem laid by the Coalition, though much of this spending is to come.

Apart from allowing bracket creep, the only way to eliminate a structural deficit is via explicit cuts in spending and "tax expenditures" (special tax breaks), and explicit tax increases.

With tax cuts and tax expenditures playing such a big part in creating the structural problem, to resolve to fix it solely via spending cuts is a recipe for failure. That's the lesson of last year's disastrous budget.

The obvious way to begin eliminating the structural deficit is to reverse at least some of the irresponsible tax expenditures that gave rise to it. However, if Turnbull summons the courage to act on super and capital gains, it's likely he'll use the proceeds to make his tax package look fairer, not to cut the deficit.

The third reason for doubting we'll ever see budget repair also concerns opportunity cost. Even a leader as popular as Turnbull has a limited supply of political credit to draw on.

The more points he uses on the unpopular elements of his tax reform package, the fewer are left to cover the unpopular measures needed to get the budget back to balance.

Saturday, November 7, 2015

CSIRO fills Treasury's gap on environment modelling

After Treasury's hopelessly inadequate attempt to peer into the future in its intergenerational report earlier this year, just look at the far more fair dinkum future-viewing exercise that CSIRO unveiled on Thursday.

Treasury's effort was little more than a propaganda exercise about the need to restrain government spending, and showed clear signs of government interference. It was widely criticised for purporting to tell us what could happen to the economy over the next 40 years while making no allowance for the effects of climate change and other environmental problems.

By contrast, CSIRO's peer-reviewed modelling exercise attempts to look at what may happen to the economy out to 2050, after accounting for the economic effects of climate change – and our efforts to reduce it – plus other environmental problems such as energy use, water use and use of other natural resources.

This attempt to integrate changes in the natural environment with standard economic modelling is a heroic effort, the first time to my knowledge it's been attempted for our economy.

It's contained in CSIRO's first Australian National Outlook report, but also reported separately in this week's issue of the prestigious scientific journal, Nature.

The project was directed by Dr Steve Hatfield-Dodds, a former Treasury economist now with CSIRO, with participation by another three economists and 13 scientists, mainly from CSIRO.

The question they sought to answer was whether the mounting ecological pressures in Australia can be reversed while our population continues growing and our material living standards continue rising.

To put it another way, can economic growth be "decoupled" from natural resource use and environmental stress?

The modelling takes a fairly conventional "computable general equilibrium" model of our economy, but surrounds it with eight other models of different aspects of the environment – global climate change and economic growth, water use, energy use, transportation, land use, material flows and biodiversity – which have effects on the economy.

But can any person or model accurately predict what will happen in the future? Of course not. So the exercise identifies 18 different plausible "scenarios" of how things may unfold and runs each of them through the nine-model set-up.

Each scenario combines differing global drivers of change with differing domestic drivers. The global drivers cover differing rates of growth in the global population by 2050 – it may grow to 8 billion, 9 billion or 11 billion – and differing rates of greenhouse gas emission.

Limiting global warming to 2 degrees above pre-industrial levels by 2100 would require "very strong" efforts to "abate" (reduce) emissions. Limiting it to 3 degrees would require either a "strong" abatement effort if the global population was allowed to grow to 11 billion, or a "moderate" effort if the population grew only to 9 billion.

That leaves "no abatement action", with the global population growing to 11 billion and global warming reaching 6 degrees. Gasp.

The domestic drivers of change cover differing degrees of improvement in agricultural productivity, differing land-use changes from the development of reforestation markets for sequestration of carbon dioxide or for protection of biodiversity, individuals' take-up of opportunities to use energy and water more efficiently, how much of our improving productivity we take as reduced working hours rather than higher real incomes, and how much of our consumer spending we devote to buying "experiences" rather than goods.

(Turns out those last two drivers made little difference to environmental outcomes, according to the model.)

It's assumed that Australia's abatement effort is at the same rate as the global effort. Up to half our net reduction in emissions is achieved by "carbon sequestration" – withdrawing carbon dioxide from the atmosphere and storing it in plants – achieved by reforestation of cleared land.

So, we build this amazing nine-model model, then run each of the 18 different scenarios through it. What results do we get?

In all scenarios, the economy and living standards are projected to grow strongly. The value of economic activity (gross domestic product) is projected to rise 10-fold over the 80 years to 2050 (the exercise actually starts in 1970, with actual data up to 2012).

This increase in GDP is driven by a 2.9-fold increase in population, leaving a 3.2- to 3.6-fold increase in GDP per person.

On some scenarios, net greenhouse emissions fall to zero or lower by 2040. From four times the global average today, our emissions per person could fall below the global average by 2050.

Apart from reforestation, emission reduction comes from reduced emissions (within Australia, not elsewhere) and from the economy's reduced resource-intensity (that is, fewer natural resources being used to generate each dollar of GDP).

National water extractions are projected to maybe double in 2050, but up to half this increase could be met by desalination in coastal cities and water recycling for industrial use.

Water stress – seen in rain-fed water use in water-limited catchments – improves or is stable in seven of the 18 scenarios.

Pressures on biodiversity (preservation of species) could also be reduced despite economic growth and increased agriculture. But carbon and biodiversity tree-planting could increase the pressure on river-based water systems.

Overall, 13 of the 18 scenarios show improvement in a least one environmental indicator, but only three – each requiring "strong" or "very strong" abatement effort and development of reforestation markets – show improvement in all three environmental indicators.

So the modelling suggests economic growth can continue without worsening – and even while improving – pressures on the natural environment, but only if we and the rest of the world greatly increase our efforts to reduce emissions.

Now, I should warn you that modelling exercises – economic and scientific – are always subject to limitations and open to criticism. They rely on many assumptions and are widely misused by vested interests.

I'm sure in 20 years' time, this CSIRO modelling will look very crude. Right now, however, it's a wonder of the modern world.

Wednesday, November 4, 2015

Why we're sure to be voting on a rise in GST

About a year ago, I began confidently predicting the Coalition would not be going to next year's election with any proposal to increase the goods and services tax. I've been tardy in advising you that, with the removal of Tony Abbott and the ascension of Malcolm Turnbull, that prediction has become, as George W. used to say, inoperative.

Indeed, I now confidently predict the Coalition will be seeking the voters' agreement to an increase in the GST.

Why the reversal? Turnbull doesn't have much choice but to run with a GST increase for pretty much the opposite reasons that Abbott had little choice but to avoid one.

Abbott and his treasurer, Joe Hockey, would love to have championed a GST rise – and, early in their term, fully intended to do so – but their disastrous first budget, with its blatant unfairness and broken promises, robbed them of their popularity, authority and trustworthiness.

They repeatedly demonstrated their inability explain complex and controversial policy proposals.

But the government's big-business backers – not to mention most economists – have convinced themselves the only cure for the sluggish economy is major economic reform, and top of their list is a cut in the rate of company tax, plus a cut in the top rate of personal income tax.

This is why they became so dissatisfied with Abbott and Hockey, and so expectant of better things from one of their own, Turnbull.

The whole country knows Turnbull will be a better manager of the economy than Abbott and that if this silver-tongued barrister can't "sell" economic reform, no one can.

So great is the confidence in the confident Turnbull that the best way for him to stumble would be to baulk at this challenge.

Trouble is, by the time he's knocked tax reform into political shape, it will have fallen well short of its proponents' grand vision, won't deliver the promised economic benefits and won't make much difference to anything, apart from making the tax system less fair.

Right now, Turnbull is grappling with the desired shape of the GST increase. My guess is he'll definitely want to increase the rate of the tax, and won't go through all the angst for a piddling increase to 12.5 per cent. No, he'll go all the way to 15 per cent.

Broadening the tax's narrow base is more problematic, as the academics say. My guess is he'll avoid the practical minefield of extending the tax's coverage to health and education (even though taxing private health insurance and private schools would do much to reduce the tax's regressiveness​), but may include financial services.

His big temptation will be to tax fresh food but, though this would greatly increase his takings, it would also greatly increase the tax's regressiveness (because low-income households devote a much higher proportion of their budgets to food than high-income households do) and thus require much of this gain to be returned as "compensation", while adding much agonising and indignation from the elderly.

Of course, the GST increase will just be part of a much bigger package of tax reforms. Since the object of the exercise will be to change the "mix" of taxation – increasing indirect taxes on consumer spending while reducing direct taxes on income – it will include big tax cuts.

Turnbull will learn from his predecessors' blunder and ensure his reform package looks fair by including imposts aimed mainly at high-income earners. If he decides to cut the top rate of income tax – benefiting just the wealthiest 3 per cent of taxpayers – he'll probably include a crackdown on superannuation concessions and discounted capital gains tax favouring the well-off.

He'd also want to throw in abolition of some inefficient state taxes, such as the stamp duty on insurance policies.

He's making it very clear that low- and middle-income families would be protected from the effect of the higher GST by adequate compensation, in the form of special increases in pensions, dole payments and family benefits. People on low wages would be compensated by tax cuts.

But just because Turnbull has the smarts, political credit and credibility to raise the GST and hope to keep his job, this doesn't give him a magic wand to wave away the iron laws of arithmetic.

The sad truth is that the untiring advocates of a higher GST have plans to spend the proceeds many times over. Big business wants to devote the proceeds to covering the cost of cutting the rate of company tax.

The nation's grossly over-taxed chief executives want to use the proceeds to cut the top rate of income tax – all to produce a flowering of innovation and agility, naturally.

Then there's the Treasurer and his department, who profess to want to use the proceeds to counter the effects of bracket creep on everyone paying less than the top rate.

And, finally, there are the premiers, who think they own the GST and want to use the proceeds to cover the ever-rising cost of their spending on schools and hospitals. In principle and in political reality – although not strict legality – the premiers have a veto over any increase.

As ever, they'll go along with the deal once they've extorted enough moolah from the feds. Right now, they're in negotiating mode.

But not to worry. St Malcolm has promised to square the circle.

Monday, November 2, 2015

Econocrats propose same old answer to all problems

If Malcolm Turnbull wants policy reforms that make the economy more innovative and agile, he should think long and hard before accepting advice from the economists in Treasury and the accountants in the department of Finance.

If you want innovation and agility, the last people to whom you should look for help are the two professions that, in their approach to problems new or old, demonstrate minimal innovation or mental agility.

I wouldn't want to call them insane, but they certainly recommend the same solutions over and over, while expecting different results.

The trouble with both professions is that their expertise is so narrow: they know a lot about just one aspect of the problem and little about all the other aspects, which they tend to ignore - while failing to warn their clients to match their advice against the advice of experts in other areas.

In the case of economists, they know what the economy needs, but they don't know much about what the economy needs and, thus, how to go about getting it.

For instance, economists see consumption as "the sole end and object of all economic activity". So they're experts on consumption, are they?

Well, no, not really. They couldn't, for instance, tell you how to maximise the utility you derive from your spending on consumption. Not their department. Better to ask a psychologist.

Economists know that improving productivity is the key to achieving faster economic growth and ever-rising material living standards. In fact, in the long run productivity is "almost everything".

So, could you give us a list of 10 things we could do to lift productivity? Well, no, not really. We don't actually know much about how you get productivity, we just know it's a great thing to have.

Of course, we do know a key source of productivity improvement is technological advance. Great, so how does technological advance work? Sorry, we haven't studied it much. We did have a go at developing an "endogenous growth theory" in the 1980s, but we soon gave up.

So what exactly is economists' area of expertise? They'd never admit it, so I'll tell you: prices. They know heaps about how the price mechanism works (given a host of mainly unrealistic assumptions), but not much else.

To make it sound sexier they may tell you economics is "the study of incentives". But in the economists' lexicon, incentives is just a synonym of prices. That's because economics pretty much ignores anything that can't be quantified, so the only incentives economists are conscious of are monetary incentives.

This assumption - that the power of monetary incentives is quite unaffected any other motivations (e.g. Turnbull only knocked off Tony Abbott because prime ministers are paid more than ministers) - does much to explain why the solutions economists propose often work so badly, with so many "unintended consequences".

Note that, in the mind of an economist, things like taxes and wages are just prices. This does much to explain economists' apparent obsession with taxation. It's a government-controlled price that seems to have much to do with the things politicians worry about these days.

It's a way for economists to appear to have useful advice on problems they don't really know much about.

Q: How should we encourage people to work more? A: cut the company tax rate and the top rate on individuals.

Q: How should we encourage people to save more? A: cut the company tax rate and the top rate on individuals.

Q: How should we encourage people to invest more? A: cut the company tax rate and the top rate on individuals.

Q: How should we encourage innovation? A: cut the company tax rate and the top rate on individuals.

Q: How can we make the economy more agile? A: cut the company tax rate and the top rate on individuals.

In sum, their preferred advice on such questions is: get the [monetary] incentives "right" and stand back.

Anything more specific to suggest? Yes, prime minister. Increase the tax incentives for spending on research and development. Give more money to scientific outfits like the CSIRO.

But haven't you guys been advising governments for years to keep cutting R&D tax breaks and money to CSIRO? Yes, prime minister, but that was when we wanted to cut the budget deficit and didn't care how we did it. Then, we didn't give a stuff about innovation and agility.

How come your advice on tax reform invariably favours high income-earners? Because when you're giving advice on matters you don't know much about, it's much less critically scrutinised when it happens to favour the rich and powerful.

Saturday, October 31, 2015

How digital disruption affects jobs and wages

A lot of people worry about the bad economic consequences of the digital revolution. Among the worriers is Dr Andrew Leigh, the shadow assistant treasurer and a former economics professor at the Australian National University.

Leigh made his concern clear in the "distinguished public policy lecture" he delivered this week at Northwestern University in Chicago.

But whereas most people worry that the digital revolution will lead to mass unemployment, Leigh's concern is that it will make our incomes a lot more unequal.

It's not surprising that people observe all the workers whose jobs are taken by computers and worry about widespread joblessness. As Leigh observes, this concern has been around at least since 1811, when disgruntled Nottingham textile workers wrote to factory owners under the pen-name of Ned Ludd, threatening to smash machines if they continued to be used.

But economists soon learnt not to worry. Why not? Speaking to an audience of economists, Leigh regarded it as too obvious to need explaining.

But let me fill you in. New technology leads to increased productivity – more goods and services produced per worker.

This constitutes an increase in the community's real income. When that increased income is spent, more jobs are created.

So whereas non-economists see only all the jobs that have been lost as industries X and Y digitise, economists understand this is just the most visible part of a more complex process in which jobs aren't so much destroyed as "displaced" – taken from some industries and moved to others.

This is why, after 200 years of labour-saving technological advance, we're still only up to having 6 per cent of the labour force unemployed (or about twice that if you add in underemployment).

Of course, this is the economy-wide outcome. The new jobs being created elsewhere in the economy may be very different to the jobs being lost. So this still leaves a problem for those individuals whose skills fitted the old jobs but not the new ones.

This is where Leigh comes in with his concerns about the effects of a newer idea – "skill-biased technological change" – on the unequal distribution of income between workers and, hence, families.

This is the idea that digitally driven technological change tends to disadvantage workers with less skill, and advantage those with more skill. It tends to lower wages for those with less education and raise wages for those with more education.

But the story's a bit trickier than that sounds. Research by David Autor, of the Massachusetts Institute of Technology, suggests jobs can be divided into three categories: manual, routine and abstract.

Abstract jobs – which typically involve problem-solving, creativity and teamwork – tend to be paid a lot more than manual jobs, with routine jobs – occupations such as bookkeeping, administrative support and repetitive manufacturing tasks – in between.

Autor has found that, over the past 30 years in America and the past 20 in Europe, it's routine jobs that have shrunk most. Why? Because they're the jobs that can be done most easily by a computer.

It's turned out that manual jobs – such as cooking, cleaning, being a security guard or providing personal care – are much harder for computers to do. For instance, the problem of shape recognition means that, a best, it takes a robot 90 seconds to fold a towel.

Robot hairdressers do a job similar to what you'd do if you drank a bottle of tequila and tried cut your own hair without a mirror, Leigh says.

He says the job characteristics that are hardest for computers to mimic include those involving communicating clearly with co-workers, showing empathy to clients and adapting to new situations. A lot of manual jobs require these skills.

Many studies – including some Australian ones – show that recent decades have seen a polarising or "hollowing out" of employment. There are a lot more abstract jobs (particularly managers and professionals) and modest growth in the number of manual jobs, but many fewer routine jobs in the middle.

But Leigh says this loss of mid-skill jobs doesn't mean the pain has been greatest for mid-skill workers and middle-income families.

Why not? Because what happens to wages is a product not just of the (declining) demand for mid-skill workers, but also of the supply of workers willing to do low-skilled manual jobs. And as job opportunities have declined for mid-skill workers, more of them have become willing to do manual work rather than be jobless.

So it's been wages at the bottom that have grown most slowly, not wages in the middle. (Because our wage-fixing system is more regulated, this is probably truer in the US than it is in Oz.)

At the top, Leigh says, it's altogether a different tale, with technology actually adding to the skills of the most skilful, making them more productive and so adding to their pay. A top surgeon, for instance, can use technology to do a better job and do more operations per day, thus adding to the demand for his (rarely her) services.

This may partly explain why chief executives' pay is rising, according to Leigh. The biggest firms have got bigger in recent years, and this is partly explained by better technology making it easier to manage larger and more far-flung businesses. As companies get bigger, the boss's pay gets bigger.

This is skill-biased technological change. Technology also helps explain the rise of "winner-takes-all" job markets for such people as actors, pop stars and top sportspeople.

People want to see the very best, much more than the almost-as-good, they'll pay more to do so and technology makes it possible.

At a time when technology is working to make the rich a lot richer and the poor only a little less poor, should we be "reforming" the tax system in ways that add to this income inequality or reduce it?

Wednesday, October 28, 2015

We need more agile thinking about "reform"

What do we want of our government? What should it to do for us? It's clear from his recent observations that our new Prime Minister is thinking hard about these things. Good. But we – the governed – should be thinking about them, too.

Malcolm Turnbull says his government's goal will be to set Australia up "to remain and be secure as a high-wage, generous-social-welfare-net, first-world country".

Speaking in Parliament, he said that "the business of government is to get things done. Australians expect us, their elected representatives, to deliver practical, commonsense policy that will improve economic security and general wellbeing".

The coming election, he told interviewers, will be fought primarily "on economic management and competing visions for Australia".

The fact is, Turnbull's predecessor wasn't much interested in the stuff of economics.

So it's not surprising that Turnbull has arrived at a time of great frustration – and expectation – among those business people, economists and media commentators who see the economy growing only slowly and have convinced themselves that major "reform" – especially changes to taxation – is the only thing that will secure our future.

There's no denying that the economy isn't performing particularly well at present, that it needs to be continuously and carefully managed and that, with the world continually changing around us, there's often a need to change the way we regulate particular aspects of the economy.

But we need to use the government's new start to think through something more basic: how do economic concerns fit with all our other concerns?

We've been living in a period where the people with the loudest voices want economic concerns to be paramount. What we need most is faster economic growth, because that's the way we keep increasing our material standard of living.

The implications of all this extra economic activity for the environment, for the distribution of income between rich and poor, for the adequacy of the help given to the disadvantaged, are things we can't afford to worry too much about.

This may be the attitude of some powerful people, but I doubt if it's what most of us want. So if Turnbull wants to be a successful, long-lasting leader of the nation, he'll need to be on about a lot more than changing the tax system in ways that suit big business.

He'll need a "competing vision for Australia" that's a lot broader than good economic management. He needs to remember that "economic security" is about more than having more money than you had last year. And "general wellbeing" covers a lot more than income and jobs.

What do we want of our government? There is much Turnbull could do to improve our "general wellbeing" that doesn't involve what's normally classed as economic reform.

For instance, he'll do a lot to protect our general wellbeing if he resists pressure from commercial interests to reduce penalty wage rates and increase shopping hours and thereby avoids making it much harder for many husbands and wives to socialise with their children – let alone relatives and friends – at the weekend.

How exactly does weakening the weekend leave us better off? Is it OK if avoiding work on the weekend remains possible for the well-paid but not the poorly paid?

Our efforts to reduce domestic violence – which probably need to be greater – can't be classed as economic reform, but would do much to improve the daily lives of many wives and children.

Right now Turnbull is being urged by business people and economists to make the economy more efficient with "reforms" that would do so at the expense of widening the gap between high and low income-earners.

But there are plenty of changes Turnbull could make that raise productivity and participation in the labour force while actually benefiting the less well-off.

It's so commonplace that economists have stopped noticing it, but by far the greatest source of inefficiency in our economy is our high rate of unemployment and underemployment. All those people willing to work but unable to find suitable employment.

Most of the unemployed are unskilled. Many are early school-leavers with inadequate literacy and numeracy. This at a time when technological change is reducing job opportunities for the unskilled but increasing demand for the well-educated.

For decades we've been allowing kids with learning difficulties to get through school unassisted, to live a life in and out of employment, on and off the dole.

The Gonski funding changes could have done much to reduce this problem, but they're dismissed as an expensive social welfare measure we can't afford, rather than an economic reform that could pay big dividends.

It's a similar story with the national disability insurance scheme, where the Productivity Commission itself estimates that its proper implementation could make a significant contribution to economic growth.

Professor Allan Fels has argued that better assistance to people with serious mental illness could greatly benefit the economy by getting more of them off the disability pension and into jobs.

Better public transport could not only reduce the long commuting times faced by people in outer suburbs, but also make our big cities more productive.

Turnbull will be a great prime minister if he's smart enough to see that there's more to improving the lives of Australians than giving tax cuts to the well-off.

Monday, October 26, 2015

To be great, Turnbull must govern for the other side

A great attraction of my job is that I'm paid to offer gratuitous advice to everyone from the prime minister down. So step up, Malcolm, it's your turn.

Everyone has high hopes that Malcolm Turnbull will be the successful, long-lasting prime minister so many of us have been seeking. Business people are hoping he'll deliver the economic reform we need to rejuvenate and energise the economy.

Though his performance won't fail to disappoint those hoping for a perfect politician, it's reasonable to hope for a big improvement on his immediate predecessors, Liberal and Labor.

Turnbull is so intelligent, so articulate, so self-assured it's become possible to believe he can do something that, until now, seemed impossible: reverse the continuing decline in standards of political behaviour.

It's doable if he uses his present commanding lead in the polls to keep the political "conversation" positive, adopts some necessary if controversial policies and devotes all his effort to explaining and defending those policies, rather than incessantly telling us how terrible his political opponents are.

He starts with much goodwill and needs now to turn it into abiding respect by the way he conducts himself as the nation's leader, not a barroom brawler. A leader who brings us together in a common cause, not one seeking to divide and conquer.

It's already becoming apparent that when a new and popular leader chooses the high road, his opponents feel a need to match him, putting up a contest of ideas and policies, not negativity and electoral bribes.

As the election approaches, Turnbull should protect his credibility by keeping promises to a minimum, being sure those he does make are deliverable or setting out up-front the circumstances that would oblige him to abandon them.

Turnbull is no political apparatchik. He came to politics late after successful careers as a journalist and a barrister, having made his fortune as a merchant banker.

This is a good sign. The guy could have retired to count his millions – or make a few more – but entered and stayed in politics to have a crack at being PM.

Why? It's more likely to be because he hopes to be seen as one of our great leaders than because he wants to keep the seat warm for as long as possible.

This suggests he'll be more willing to run a few calculated risks in the interests of notching up some memorable achievements.

It's true Turnbull has already had one short-lived and undistinguished stint as leader of the Coalition. But that's just as true of the Liberals' most long-lasting and celebrated leaders, John Howard and Bob Menzies.

As with those two, Turnbull's first, abortive attempt will prove an asset provided he's used his time in the wilderness to correct the personal weaknesses that caused his initial failure.

If a high IQ is Turnbull's greatest strength, his greatest weakness is a low EQ – a shortage of emotional intelligence. He can be charming when he wants to be, but mostly he prefers you to stand back and admire while he demonstrates his towering intellect. Hardly endearing.

All successful politicians understand that, though they hold more power than most, in any democracy power is widely diffused, so you must always be trying to add other people's power to your own to ensure you've got enough to prevail.

To this end you need to consult widely, include others in the decision-making, listen patiently while people give you free advice, and school yourself to suffer fools gladly.

But if Turnbull really wants to make a difference, his notion of reform needs to be a lot more creative than simply bringing to reality all the rent-seeking "reforms" long advocated by big-business people and their economist handmaidens, who've never had an innovative, intellectually agile policy idea since they encountered the neo-classical model in first year uni.

Turnbull's unlikely to get far if he allows himself to seen as a rich man delivering for his well-off mates at the expense of the rest of us. Every new PM promises to "govern for all Australians"; more than most, Turnbull must demonstrate he really means it.

Paul Keating and Bob Hawke made their names as micro reformers by implementing changes that gave their own supporters more heartburn than the other side's; by doing things the Libs should have done but weren't game to.

Similarly, Turnbull needs to show up his opponents, proposing reforms they could only dream of – but can't now oppose without losing all credibility.

The key is to look for reforms that improve equity at the same time as they enhance efficiency. There are plenty if you look.

Saturday, October 24, 2015

Timid financial changes get Turnbull started on reform

Since the election of the Coalition government we've heard a lot more talk about the need for micro-economic reform than we've had actual reform.

Indeed, the main "reform" we've had so far has been abolition of the previous government's chief reforms: the carbon tax and the mining tax.

But all that changed this week, with the announcement of the Turnbull government's response to the recommendations of the Murray inquiry into the financial system.

Next will come the government's response to the Harper inquiry into competition policy, then its proposals for tax reform – and possibly for changes to industrial relations – both to be taken to next year's federal election for approval by voters.

There's no doubting the importance of the financial system and the need to ensure it's performing well.

According to the Australian Centre for Financial Studies, our financial services industry is a cornerstone of the economy – the largest industry, the largest payer of company tax, a major employer of highly skilled workers and a large source of service exports.

The finance industry carries out all the payments made by households, businesses and governments. Its banks act as "intermediaries", taking the money of savers and lending it to investors, in the process affecting "maturity transformation" by borrowing for short periods (say, "at call") but lending for long periods (say, 30 years).

The industry – particularly its insurance companies – helps the community manage risk (say, that your house burns down, or that the person to whom your savings have been lent goes broke). It also manages our financial assets, such as our superannuation savings.

Of course, to say the finance industry is vital to the functioning of the economy is not to say it may not be a lot bigger than it needs to be, nor that all the trading in financial assets it engages in is necessary and productive, nor that its top people should be paid the eye-popping salaries they are.

But that's a story for another day. Today's story is that though the financial sector is a key part of the economy, the reforms announced this week aren't terribly major. There are a few reasons for this.

For one thing, you can only deregulate the industry once. We did that in the 1980s, and the few rounds of reform since then have been progressively less sweeping and more in the nature of fine-tuning.

For another thing, the global financial crisis in 2008 was a harsh reminder that deregulation can go too far, that banks and other financial institutions can do stupid, short-sighted things in their search for profit, that some degree of regulation is essential and that regulators who only pretend to be regulating can end up allowing great damage to be done to the real economy.

Of course, we in Australia did keep our banks under tight supervision and did prohibit our big four from merging any further, which stood us in good stead when the Americans and Europeans were getting themselves into so much trouble.

So regular fine-tuning of our regulatory arrangements is about all we need. Even so, this week's decisions do err on the timid side. They were worked up before the ascension of Malcolm Turnbull, and the previous administration seemed keenly aware of the power of the big banks and their many lobbyists.

The government accepted almost all the inquiry's 44 recommendations and added half a dozen of its own. The main proposal it rejected was that it ban self-managed super funds from borrowing to buy property. A courageous decision, minister. Hope we don't live to regret it.

The government says its response to the inquiry covers five "strategic priorities". The first is to strengthen the financial system's resilience by reducing the impact of potential financial crises. We need to be better able to weather them and to lessen their cost to taxpayers and the economy.

Australia is a capital-importing country, which makes us more reliant on foreign capital markets than some other economies are. To account for this, the main measure is the Australian Prudential Regulation Authority's requirement that the banks – particularly the big four – hold more shareholders' capital (the cost of which they're now busy passing on to their mortgage customers).

The second priority is to improve the efficiency of the superannuation system. The government will ask the Productivity Commission to develop measures of the rival super funds' efficiency and propose ways of making funds compete for the right to be "default" funds (when employees express no preference for a particular fund).

The government has already moved to require the boards of funds to have at least a third of their members as independent directors (that is, more retired business people and fewer union secretaries).

It would be nice to believe these "reforms" were aimed at getting fund members a better deal rather than getting super funds out of the orbit of the Liberals' long-hated class enemies and into the hands of the banks and other mates.

The third priority is to stimulate innovation to "facilitate competition and reduce costs for consumers". Which is fine, provided it doesn't involve wasteful product differentiation and advertising campaigns, or new products aimed at avoiding taxation or getting around the regulation.

Fourth, to support consumers of financial products being treated fairly. The standards of financial advice will be lifted by improving the training and ethical standards required of advisers.

The Australian Securities and Investments Commission will be given power to ban or order modification of harmful financial products, but only after the government has "consulted widely" with lobby groups.

The government's final priority is to strengthen the capabilities and accountability of the prudential regulator and the securities regulator.

The absence of industry complaint about all this reform is a sign it's not ruffling many feathers (and that the lobby groups remain hopeful of being able to water down the changes before they're applied).

Wednesday, October 21, 2015

It's fine to be well-off so long as you pay your whack

It's no doubt true, as many commentators are saying, that Labor has won itself no points by reminding us how wealthy Malcolm Turnbull is. We hear frequently about "the politics of envy", but actually there isn't a lot of it about these days. You've done well? Good luck to you.

In any case, I think there's huge goodwill towards Turnbull. Everyone can see how super smart he is, and we're hoping he'll use that smartness to make Australia a better place to live. A nation with less divisiveness, less fear that baddies are out to get us, more unity, a more positive vision of what we can become and more of us doing our bit to make it a reality.

As with any politician, he'll have his share of policies we disagree with, but it would be so nice to have a prime minister all of us can be proud of.

We might even vote to keep him, despite some disagreement on particular issues. Politicians come as a package, and you never like every item that's in the Christmas hamper.

But to say few Australians envy the well-off is not, I hope, to say we don't mind how little tax they contrive to pay, or how hard they struggle to avoid their obligations to the rest of the community.

Turnbull says of himself and his wife, Lucy, that "we've worked hard, we've paid our taxes, we've given back". It's the giving-back bit I like. And, of course, paying your taxes – in Australia, and in full, according to Turnbull – is the first and most basic way we "give back".

What really gets to me is not the people who've done well for themselves, but their seemingly growing inclination to be mean and grasping about it. I hate their selfishness and their self-congratulation.

I've worked hard for all I've got, it's all mine, but now you have the effrontery not just to make me pay taxes, but want me to pay a lot more than other people.

Taxation isn't theft and never was. Taxes are the price we pay for a civilised society, as someone once said. And he was even an American.

Expecting the better-off to pay a higher proportion of their income than the less well-off isn't socialism – as the better-off increasingly tell each other on social media - it's the Australian way. You put more in and you get back less. Why? Because you're fortunate enough to be able to afford it.

The Aussie way is that if you don't need the dole or the pension, you shouldn't get it. What's more, you should be too proud to ask for it.

It's not the Aussie way to boast about how much tax you pay, but perhaps we'd be better off if it was. Tax-paid as a status symbol. I paid far more tax than you did last year – see how successful I am?

As for self-congratulation, the bit I liked best in Turnbull's defence of his wealth was his lack of it.

"The fact is that Lucy and I have been very fortunate in our lives ..." he said. "I don't believe that my wealth, or frankly most people's wealth, is entirely a function of hard work.

"Of course, hard work is important but, you know, there are taxi drivers that work harder than I ever have and they don't have much money. There are cleaners that work harder than I ever have, or you ever have, and they don't have much money."

The world is full of people – mainly men – claiming to be "self-made" who are anything but. They seem utterly oblivious to the extent to which their wealth is owed to good fortune rather than hard work.

We're all fortunate to live in Australia. Baby boomers are fortunate to have been born at a time when few were required to go to war, when you could get a good education at little cost, leading to a good job and little unemployment. When buying a home wasn't all that hard and you got in early for a 40-year stint of ever-rising house prices.

It's only relatively recently that many people have begun inheriting sums of money worth talking about. But to see yourself as self-made merely because you inherited no wealth is self-delusion.

IQ is, to a large extent, inherited. And EQ – self-discipline and the ability to get on with other people – is often something we gain from our parents' example. It's good fortune to be born into a family of readers.

All this is why "equality of opportunity" is a worthy goal for public policy, but something no government could ever get anywhere near attaining.

Back to Turnbull: "There is a lot of luck in life and that's why all of us should say, when we see somebody less fortunate than ourselves, 'There but for the grace of God goes me'."

You don't have to be any kind of believer to believe that – and be better for it.

Giving a helping hand to those who weren't issued with as much grace as we were is why, brothers and sisters, we should pay our fair whack of tax and do it cheerfully, grateful we can so easily afford it.

Monday, October 19, 2015

Banks ponder their next game with interest

Actual mortgage interest rates have fallen from 7.1 per cent to 4.7 per cent over the past five years, but let one bank – Westpac – increase its rate by 0.2 percentage points and the righteous indignation knows no bounds.

It may not be the end of the world, but it's certainly the end of the housing boom as we know it. Well, maybe.

But outrage is a poor substitute for understanding. Why did Westpac move? Why now? Will the other three big banks match it? And will the Reserve Bank cut the official interest rate to counteract the banks' "unofficial" increase?

Standard economic theory offers little guidance to the classic oligopolistic behaviour we get from our banks. "Game theory" is supposed to be the way economists analyse the strategic decisions of oligopolists, but I doubt it offers much help, either.

Westpac made its rate move at the same time as it joined the other big boys in announcing plans to raise more share capital. The big four are acting in expectation that the government will accept a recommendation of the Murray report that it make Australia's banking system "unquestionably strong" (that is, safe) but requiring it to hold a lot more equity (shareholders') capital.

Part of this is the intention to increase the big four's capital requirement by more than the smaller banks' increase so as put the two groups on a more equal regulatory footing. Westpac gave the cost of this requirement that it hold more capital as its justification for increasing mortgage interest rates.

It's true the requirement does increase the big banks' "cost of intermediation" – that is, the cost of borrowing from some people and lending to others, which is represented by the size of the gap between the interest rate paid to depositors and the rate charged to borrowers.

In principle, this extra cost could be passed back to depositors in the form of lower deposit rates, passed forward to borrowers in the form of higher borrowing rates, or left with the banks' shareholders in the form of lower profits. Or some combination of the three.

Obviously, bank customers would prefer that the banks and their shareholders bear the cost. And there's no reason it shouldn't happen. Our big banks have long been extraordinarily profitable – making a return on equity of 15 per cent a year – in a business that's virtually government-guaranteed.

They could easily take the hit. There's nothing sacred about 15 per cent. And in an intensely competitive banking market that's probably what would happen. In our world, however, "greedy" (read profit-maximising) banks will protect their profitability to the extent that market conditions allow.

And right now they do. It's clear Westpac's intention is to pass the higher cost on to its borrowers. Its three big competitors now must decide whether to follow suit or leave it hanging out to dry as they try to win market share from it.

Going on past behaviour, they'll follow suit. After all, a few months ago when ANZ bank raised its interest rate on investor mortgage loans by about 0.25 percentage points, the other three lost little time in doing the same. The justification was the same: the cost of the tighter capital-adequacy requirement.

But this doesn't guarantee that, this time, the others will follow Westpac immediately or by as much as 0.2 per cent – which, by the way, also applies to investor loans.

One question all this raises is whether the banks are raising rates by more than required to recoup their higher costs. The Murray report said a 0.1 or 0.15 percentage-points rise would cover it.

So, why so much, and why now? Because, at the present exceptionally low rates, the demand for home loans exceeds supply, with the banks under pressure from the authorities and sharemarket analysts to avoid lending too much – to ordinary home-buyers, not just investors.

If you have to cut back your rate of lending, why not do it by raising your prices? This suggests the housing boom may indeed be reaching its closing stages.

One reason the other banks may delay following Westpac is the talk that the Reserve will respond by cutting the official interest rate on Melbourne Cup day. They'd love to be able to hide a rate rise behind a less-than-full pass-through of a rate cut.

The Reserve may oblige, but I won't be holding my breath. Nothing in its rhetoric to date suggests it's keen to cut rather than wait. And I doubt if it would want to be seen as trying to prolong the house-price boom.

Saturday, October 17, 2015

Nitty-gritty of unemployment shows small improvement

Why does unemployment increase? For a lot more reasons than you probably imagine.

It's a good question to ask this week when the media informed us that, last month, the number of people in employment fell by 5000, the number unemployed fell by 8000 and the proportion of people participating in the labour force fell from 65 per cent to 64.9 per cent, but the rate of unemployment was unchanged at 6.2 per cent.

I could devote the rest of this column to trying to explain that puzzle. Or I could say that the media and the markets make the jobs figures more puzzling than they need to be by focusing on the version of them that jumps about from month to month for no apparent reason, rather than looking at the smoothed, "trend" figures the Bureau of Statistics calculates for the express purpose of helping us see what's going on.

Those figures show the rate of participation rising by a fraction in September, as employment rose by more than 12,000 and unemployment rose by 4000, which wasn't sufficient to change the rate of unemployment from 6.2 per cent – pretty much where it's been sitting for a year.

So back to the question: why does unemployment increase? You can answer that at the macro-economic level or the strictly mechanical level.

From an economy-wide perspective it's obvious: unemployment increases when the economy turns down. But that's not the full story. Unemployment can increase even when the economy's growing steadily and employment's increasing.

Why? Because the labour force is always growing, thanks to "natural increase" (more young people entering than retired people leaving) and immigration. This means the economy and employment have to be growing at a certain rate just to stop unemployment rising.

With that sorted, let's look at the mechanics. Why does unemployment increase? Because people lose their jobs?
Yes, but that's just the biggest reason. As well as those workers who are sacked or laid off are those leaving their jobs voluntarily, hoping to find a better one.

Then there are former workers re-entering the labour force to look for work and, finally, the new entrants to the job market, including young people leaving school or university.

Set beside that, the oppose question – why does unemployment decrease? – is easier: either because people find a job, or because they give up looking and so get reclassified as NILF – not in the labour force.

I raise all this because, Kieran Davies, chief economist of Barclays Bank, has been delving deep into the official figures to get a better idea of what components have been driving unemployment in recent years.

In very round figures, he found that "job losers" account for about 40 per cent of all the unemployed, with "job leavers", "re-entrants" and "new entrants" accounting for about 20 per cent each. Bet you didn't know that.

Next Davies looked more finely at how each of the four categories has been contributing to the rate of unemployment since its most recent low point of about 5 per cent in 2010-11.

He found that most of the increase in unemployment since then is explained by an increase in job losers, caused by "job shedding" by employers.

Unemployment resulting from job shedding rose from a low of 1.7 per cent of the labour force in 2010 to reach 2.4 per cent in late 2014. This was just under the peak of 2.6 per cent reached during the global financial crisis.

Most of these job losses were in mining, manufacturing, professional services and education, Davies finds.

Since late last year job shedding has eased a little, so the stock of job losers has fallen a fraction to 2.3 per cent of the labour force. A good sign, even if a small one.

The stock of (voluntary) job leavers reached a multi-decade low of 1 per cent just before the global financial crisis, when it was easier to line up a new job before jumping.

It then moved up to 1.4 per cent in 2014, its highest level since 2002. This is a sign of increasing confidence – don't worry, I'll soon find one – though it's recently eased back a little to 1.3 per cent.

Former workers seeking to re-enter the workforce accounted for just 0.9 percentage points of the overall rate of unemployment during the global financial crisis, another multi-decade low.

Clearly, not many married women and others thought it a good time to be actively seeking a job.

But with returning confidence since then the rate has steadily increased to 1.4 per cent, its highest since 2003.

That leaves new entrants to the jobs market. The proportion of these people who'd failed to find work fell to a multi-decade low of 0.9 per cent just before the financial crisis, before rising to just over 1 per cent following the crisis.

The proportion rose to 1.3 per cent in 2013, according to Davies' calculations, a sign that education leavers have borne much of the brunt of the relatively weak economic and employment growth in recent years.

Fortunately, the proportion has since eased to 1.1 per cent, which may suggest education leavers are having less trouble finding a berth, though it may mean we've had fewer overseas people – including students and backpackers – coming to Oz and looking for work.

Putting all this together, it's reasonably good news. We already know – and this week's jobs figures confirm – that unemployment has been steady for a year or more, even though the economy hasn't been growing all that strongly.

Davies' delving tells us the worst contributor to unemployment – businesses shedding jobs – has stopped getting worse and fallen back a little, to have its place taken by more hopeful contributors, former workers re-entering the market.

Davies' prediction is that the unemployment rate will remain steady, though there's a chance it may fall a little.

Wednesday, October 14, 2015

Moratorium on new coal mines makes economic sense

What are we meant to do about coal? For some time now it's looked like Australians face a painful choice between doing the right, moral thing by the rest of the world and continuing to make a living from our rich endowment of natural resources.

The burning of coal is by far the biggest source of the greenhouse gas emissions that are causing climate change. Australia is one of the world's biggest producers of coal.

Greenies have been arguing for years that, although it's too much to ask that we just stop exporting the stuff, we should at least get in no deeper by ceasing to build any new mines or expand existing mines.

In August, Anote Tong, President of the Republic of Kiribati, called for an international moratorium on new coal mines as a way of underpinning the efforts to get increased commitment to reduce emissions at the Paris summit in December.

Not surprisingly, Tong's call for a moratorium has been supported by 11 other Pacific island nations worried about rising sea levels. But he's also winning support from such influential figures as the Nobel Prize-winning scientist Peter Doherty and the British economist Lord Nicholas Stern.

For such an international moratorium to be effective, we'd have to be part of it. At present, we have 52 proposals to build new coals mines or expand existing ones.

But isn't it too much to ask us to leave all that black gold in the ground? Mining and exporting coal is an important way this economy makes its living.

The developing countries – including China and India – have a lot more developing to do, meaning they'll need a lot more energy, much of which will be coal. What's so bad about them trying to get rich like us? And why shouldn't it be we who supply that coal?

We need more jobs, and think of all the jobs building more big mines would create.

So what's it to be? Conscience or self-interest? Well, how about both?

The Australia Institute think-tank has begun campaigning hard for a moratorium, and a forthcoming paper by its chief economist, Richard Denniss, argues that economic and political considerations actually say we should be joining the moratorium.

Why? In a nutshell, because coal's days are numbered. The rapidly falling price of renewable energy such as wind and solar, combined with the growing resolve of China, the US and others to reduce their emissions, put a dark cloud over the future of coal.

Coal mines are intended to have lives of 50 to 90 years. Will coal prices be high enough in 30 or 40 years to make continued production profitable? If not, investors in new coal mines won't get their money back, but will be lumbered with "stranded assets" – assets that no longer earn much of a return.

Denniss says it's now widely accepted by international agencies that meeting the goal of limiting global warming to 2 degrees requires keeping most fossil fuels unburnt and in the ground.

All this helps explain why the world's big banks, including our own, have become markedly less enthusiastic about financing new coal mines. That – plus the present flat state of the world coal market.

According to the BP company's energy outlook, global coal consumption grew by just 0.4 per cent last year, well below its 10-year average growth rate of 2.9 per cent.

Within that, China's consumption grew by just 0.1 per cent. And Professor Ross Garnaut, of the University of Melbourne, is predicting a significant decline in China's demand for coal for the foreseeable future.

Were we to build all our proposed new mines, we'd double our annual exports. According to Denniss, just proceeding with the five biggest projects in Queensland's Galilee Basin would increase the world's seaborne coal trade by 18 per cent.

What do you reckon that would do to world coal prices at a time when coal demand is weak?

See the point? In such circumstances, preventing further coal development – including by governments declining to subsidise new mine railways and ports – wouldn't just reduce future greenhouse gas emissions.

By avoiding causing further decline in coal prices, it would also benefit the owners of existing mines, the banks that have lent to them and those who work for them, as well as the owners of present and future renewable energy projects. Not to mention the governments dependent on revenue from price-based mining royalties and company tax collections.

On its face, by causing coal prices to be higher than otherwise, it would harm the users of coal and coal-fired electricity. But when you remember that, without something like a carbon tax, the price of coal fails to include the cost to the community of the environmental damage that coal-burning does (including the death and ill health caused by the particulate air pollution from power stations), that's not anything to feel bad about.

But what about all the jobs that building new mines would have created? They're temporary and often exaggerated by the projects' proponents. Once they're built, open-cut coal mines employ surprisingly few workers.

The construction workers not employed to build more mines than are good for us could be better employed building more useful infrastructure.

When you think it through, the case for a moratorium on new coal mines has a lot going for it.

Monday, October 12, 2015

Competition does have its drawbacks

Competition is billed by economists as a wonderful thing, the invisible restrainer of a capitalist economy and essential to ensuring consumers get a good deal.

But many economists aren't as conscious as they should be that competition has costs as well as benefits.

It's true, of course, that monopoly is usually a terrible thing, allowing arrogant, inflexible behaviour on the part of producers, with little pressure on them to keep prices down or to provide much choice. Dealing with government departments shows you what monopolies are like.

Economists tend to assume the more competition the better and that customers can never get too much choice. But this shows how – despite their loud protestations to the contrary – their thinking is excessively influenced by their most basic, least realistic model of "perfect competition".

Psychological experiments show that when shoppers face too much choice, they tend to avoid making a decision. That's because the information they need to make informed choices isn't freely available and because the human mind hasn't evolved to be good at choosing between more than two items with differing characteristics.

Many real-world markets are characterised by oligopoly: a few large firms accounting for most of the sales. Oligopolies make economic sense because they're needed to fully exploit economies of scale (which are assumed away under perfect competition). So, in reality, competition and scale economies are in conflict.

In oligopolies and even in markets with a relatively large number of producers, competition is blunted by product differentiation, much of which is cosmetic. As with most advertising, product differentiation is intended to induce consumers to make decisions on an emotional rather than rational basis.

Phoney differentiation is also intended to frustrate rational comparison. It's not by chance that it's almost impossible to compare mobile phone contracts.

When economists speak of competition, they're usually thinking of competition on price. But though oligopolists watch their competitors like hawks, they much prefer to avoid price competition, competing rather via advertising, marketing, packaging and other differentiation.

Mackay's Law of competition states that the key to competition is to focus on the customer, not your competitor. But this is what oligopolists don't do.

In the real world – including the media – competitor-oriented competition is rife. This robs customers of genuine choice. It's a form of risk aversion: if I do the same as my competitor, I minimise the risk of him beating me.

It's what, in Harold Hotelling's classic example, prompts two ice-cream sellers to be back-to-back in the middle of the beach, regardless of whether some other positioning would serve customers better. It explains why business economists' forecasts tend to cluster, usually around the official forecast.

In his book The Darwin Economy, Robert Frank, of Cornell University, argues that lefties tend to see inadequate competition as the most prevalent form of market failure, whereas it's actually "collective action problems".

A collective action problem arises when the players in a market realise they're doing something mutually destructive, but no one's game to stop doing it for fear of being creamed by their competitors.

Usually in commercial markets the only answer is for the government to intervene and impose a solution on all players; for which they're grateful.

However, that's no help to our political parties, which have got themselves locked in a game of ever-declining standards of behaviour they don't know how to escape from. It's collective action problems that make it so easy for the politicians to manipulate the media.

The advocates of federalism believe it's good to have the states free to be different and competing against each other. In reality, the competition is mainly negative. The states compete to attract foreign investors with special tax concessions and the foreigners play them off against each other.

In the early 1970s, the McMahon government transferred its payroll tax to the states to give them the "growth tax" they needed to cover their growing spending. In the decades since then, they've done little but compete with the others by raising their tax-free thresholds and cutting their rates.

The huge increase in federal grants to private schools over recent decades was justified as increasing parents' choice and imposing competitive pressure on public schools. There's little evidence it's worked, nor much even that it's held down private school fees.

Similarly, Julia Gillard's My School website, with all its information about the academic performance of particular schools, intended to increase competition between them, has failed to produce any increase in the proportion of students achieving national minimum standards in reading, writing and numeracy over the five years to 2014.

Depending on circumstances, competition can make things better or worse – or little different.

Sunday, October 11, 2015

Why the Trans-Pacific Partnership is no game-changer

Think you know a bit about economics? Try this quick quiz: what's your impression of the Trans-Pacific Partnership Agreement reached between the United States and 11 other Pacific Rim countries, including Australia, this week?

Would you say it is: a) a gigantic foundation stone for our future prosperity that will boost growth, create jobs, raise living standards and increase productivity; b) a terrible deal that advantages big American multinationals at our expense, or c) not a big deal either way?

Malcolm Turnbull and his ministers' exaggerated claims about the benefits likely to flow from the agreement rest on the expectation that it will allow our farmers to sell more sugar, beef, cheese, wool and rice to the other economies, at higher prices.

Since these gains have been achieved at little cost in terms of increased access to our market for the other countries' exports, we're surely well ahead on the deal.

Does that make sense? Only if you don't know much economics.

As for the claim that it's a terrible deal, it has some truth to it, but is itself exaggerated. It's true that part of the deal involves our acceptance of "investor-state dispute settlement" arrangements, which allow foreign companies – but not local businesses – to take actions for damages against governments that make decisions which adversely affect their profits.

This is an unwarranted imposition on democratic governments' sovereignty which, at best, will involve them in significant legal costs in fending off vexatious claims.

It's true, too, that trade deals with the US have involved attempts to advantage American companies holding intellectual property – patents, copyright and trademarks – at the expense of local consumers.

And the intense secrecy in which the TPPA has been negotiated – we still don't know the details of the agreement and won't for some months – raises justified suspicion in many people's minds. What is it that big companies and lobby groups may know, but the public may not?

Even so, it does seem that Trade Minister Andrew Robb has fended off American attempts to further advantage foreign pharmaceutical companies at the expense of Australian patients and taxpayers.

In the old days trade agreements were about increasing trade between countries. These days, they're at least as much about imposing restrictions on governments' freedom to legislate as they see fit.

But to assess the likely effects on the economy – on growth, incomes, jobs and productivity – we need to set this legislative aspect to one side and focus more directly on trade and investment.

Be clear on this: there's no doubt that reducing barriers to trade between countries increases the material prosperity of the countries involved. Reduced protection and increased trade have played a significant part in the greater prosperity enjoyed first by the developed economies and then the "emerging" economies since World War II.

Most of those gains were achieved by successive rounds of multilateral reductions in import tariffs and quotas. That is, the reductions applied to all of a country's trading partners, not just some.

But the World Trade Organisation has been trying unsuccessfully since 2000 to organise another multilateral agreement. In the meantime, countries have taken to making bilateral trade deals, where the concessions made to the other country aren't available to any other economy.

This makes them preferential trade agreements, not the free trade agreements they are known as.

They're greatly inferior to multilateral agreements because they tend to divert trade from more efficient to less efficient supplier countries, simply because the less efficient suppliers happen to be subject to lower import duties.

And the picking and choosing between which countries get preferential treatment and which don't creates a need for complex "country of origin" rules that add much red tape to international trade.

This week's regional preferential trade agreement between 12 countries representing 40 per cent of world gross domestic product will still be trade-diverting to some degree, particularly since it excludes such significant trading partners as China, India and Indonesia.

But it could lessen the burden of red tape if, as mooted, it involves uniform country-of-origin rules.

The other weakness of trade deals is their encouragement of mercantilist thinking – the notion that countries get rich by exporting as much as they can and importing as little as they can – a fallacy economists have been fighting since the days of Adam Smith.

The nature of bargaining is to gain as many concessions as you can while making as few of your own as you can. But this is the exact opposite of the way you maximise the economic gains from trade.

You gain most not by inducing trading partners to reduce their barriers to your exports, but by reducing your own barriers to their exports. You gain when you shift productive resources from things you aren't very good at doing to things you are.

That's the first reason for believing a modest increase in sales for our farmers and little change for our import-competing industries won't do much to increase growth, jobs and productivity.

The second reason – and another reason mercantilism is fallacious – is that if we did get a lot higher prices for our agricultural exports without much change in import prices, this improvement in our terms of trade could be expected to lead to a rise in the value of our dollar.

If so, our farmers might be better off but this would be at the expense of our manufacturers, tourist industry and other exporters of services.

As yet we've done no modelling of the likely economic benefits of the TPPA. But various American modelling exercises – and our officially commissioned modelling of our recent bilateral deals with South Korea, Japan and China – all suggest the gains will be small – say, a level of GDP that's just 0.5 per cent higher than otherwise after 10 years. No big deal.