Big business-biased 'reform' won't fly

I'm confident this year will see the economy performing better than many people expect – those who underrate the importance of domestic influences – but I'm far from confident it will be a year of great progress on economic reform.

There are plenty of things that need reforming, but anyone who thinks the top two are the tax system and industrial relations is confusing rent-seeking with reform.

Rent-seeking involves interest groups pressuring governments to change laws and regulations in ways that advantage them at the expense of others. Look at our tax "debate" and that's just what you see.

Big business and high income-earners want to pay less tax – a cut in the rate of company tax and in the top personal tax rate – and if that means other people paying higher tax, say through a higher goods and services tax, so be it.

Naturally, their self-interest is cloaked in claims about how good this would be for the economy. Benefits going directly to the well-off, we're assured, will trickle down to the punters.

But rarely do the advocates of such reforms spell out the mechanisms by which lower rates of tax are supposedly transformed into greater effort to "work, save and invest", much less produce empirical evidence.

It's remarkable how many highly trained economists go along with this self-serving pseudo-science.

There are two giveaway signs that the present push on taxes isn't genuine reform. First, the one area where there's solid evidence that high (effective) marginal tax rates are discouraging work effort is in returning mothers' transition from part-time to full-time work, but no one's proposing to do anything about this.

Second, if people are so anxious to respond to globalisation's threat to our tax base by shifting it away from taxing mobile resources, how come they're so set on increasing the GST rather than taxing the ultimate immobile resource, land?

Of course, we've yet to see how far Malcolm Turnbull will go in seeking to give his party's business backers the "reform" they seek. If he doesn't go far, they'll brand him as lacking courage. It will be more accurate to say he lacks foolhardiness. Rejigging the tax system to favour the better-off will always be hard to sell to the rest of the electorate.

As for industrial relations reform, there's never been a time when it's less needed. Certainly not the reform that gives employers more power to limit the wage rises of their workers. This stuff is straight wishful thinking by bosses.

One thing we'll notice this year is the potential for conflict between tax reform and budget repair. It was good last week to see the secretary to the Treasury, John Fraser, discharging Treasury's sacred duty to put fiscal rectitude above all else, by reminding us of the importance of returning the budget to surplus.

Predictably, the political journalists' conclusion that Fraser was warning of the imminent loss of our AAA credit rating missed the point. Rather, he was openly correcting his masters' repeated contention that a return to "growth and jobs" (mysteriously brought about by business-biased tax reform) would fix the budget problem.

Not when the deficit you're running is more structural (caused by explicit spending and taxing decisions) than cyclical (caused by temporary weakness in the economy), he told them. So there's no substitute for hard decisions to cut spending and raise taxes.

Can the Turnbull government reform taxes and repair the budget in the same year? We'll see, but I doubt it.

In any case, it won't get far as long as it sticks to its political ideology that higher taxes are the greatest economic evil, so the only acceptable way to return the budget to surplus is to slash government spending.

Trouble with this mentality is that while it rests easily in the minds of conservative governments – and Treasury secretaries – in practice it's almost impossible to implement.

That's because it shifts the burden of repair towards welfare recipients and ordinary wage-earners, and away from high income-earners using concessions and loopholes to pay less tax than they should.

Problem: the votes of the chosen victims far outweigh the votes of the high-income beneficiaries. Surely Turnbull, Scott Morrison and Fraser learnt that from the utter disaster of the government's first budget.

He didn't say it, but Fraser's speech implied that recent increases in spending on the disabled, on disadvantaged school kids and on higher wages for welfare and childcare workers were a waste of money and needed to be chopped back.

If we never get back to budget surplus, such ideological bias and pig-headedness will be a big part of the reason.

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Economy will look better when mining investment stops falling

Here's a little tip for the start of another working year: if you want to make much sense of the economy, you need a good feel for arithmetic.

Thanks to our obsession with economic growth, we're almost always focusing on the change in economic indicators like gross domestic product and its components, such as consumer spending, business investment, imports and exports. (And the figures we look at are usually "in real terms" – they've had the effect of inflation removed from them.)

So the big focus is on whether indicators have grown or shrunk since last quarter or last year and, if so, by how much. This means I often find myself writing a sentence such as "the growth in X – exports, say – accounted for more than all the growth in GDP".

Almost every time I do I get someone saying "what? how can that be true? How can the growth in a component of the total account for more than all the growth in the total?"

If that objection makes sense to you, you're showing your lack of arithmetic imagination. It's perfectly possible for one component to grow by more than the growth in the total provided some other component shrinks. Oh, of course.

Now consider this: we've been very unhappy with our "below trend" (below average) rate of economic growth in recent years, such as our growth of just 2.5 per cent over the year to September.

But everyone knows our problem is that we're having to make a transition from growth led by mining – in particular, by the massive surge in investment in the construction of new mines and natural gas facilities – to growth led by the rest of the economy.

And rough calculations suggest that the "non-mining economy" grew by about 3 per cent over the year to September.

Since we know the economy overall grew by 2.5 per cent, this means the "mining and mining-related economy" must have contracted over the year. This is hardly surprising: mining investment spending is dropping like a stone.

It's also good news. For a start, it says we've made a lot of progress in getting the rest of the economy growing strongly.

But there's another, arithmetic point. The collapse in mining investment can't go on forever. Eventually you hit bottom and can't fall any further. When that happens, the mining sector stops "subtracting from growth".

And when mining is neither subtracting from growth nor adding to it, the quite-strong growth in the non-mining economy will be all the growth we've got – and it, we can hope, will still be growing by 3 per cent a year.

In other words, the economy should speed up as soon as it loses the drag coming from the big contraction in mining investment. And that should happen by about the end of this year.

Next, have you noticed how popular it's become to measure the budget's performance by looking at the change in the level of government spending as a proportion of "nominal" (that is, before adjusting to remove the effect of inflation) GDP?

In principle, it makes sense to compare nominal government spending with the nominal size of the economy. It's saying that the size of the economy grows for various reasons – inflation, real growth, growth in the population – and it shouldn't worry us that government spending is growing for the same reasons.

It's only noteworthy when government spending is growing faster or slower than the economy.

But here's where it helps to have a feel for arithmetic. When you keep comparing an economic variable to a particular "denominator" (the number that goes on the bottom of the sum) over many years, you're implicitly assuming that the denominator (nominal GDP, in this case) moves in a reasonably steady, reliable way.

If so, any change in the ratio (the percentage) can be attributed to changes in the "numerator" (the number that goes on the top; in this case, government spending). If the denominator isn't moving in a stable fashion, then this instability could be contributing to the change in the percentage, making it hard to be sure what's going on with the numerator.

Trouble is, the resources boom has played havoc with the stability of nominal GDP. Why? Because GDP, being a measure of the nation's production of goods and services, naturally includes our production of exports.

But we know that the prices we were getting for our main mineral exports – coal and iron ore – shot up to unheard of levels in the early part of the boom, then from mid-2011 began falling back to earth.

To see how this has affected the stability of nominal GDP, consider these comparisons (for which I'm indebted to Michael Blythe, chief economist of the Commonwealth Bank). Over the nine years to 2001-02, it grew at an annual average rate of 6.1 per cent. (This would be inflation of 2.5 per cent plus real growth of about 3.5 per cent.)

We can think of that as nominal GDP's "normal" rate of growth. But then the prices boom starts and continues for the nine years to 2010-11, during which it grew at a rapid annual average rate of 7.2 per cent.

In the four years to 2014-15, however, the fallback in export prices caused nominal GDP to grow at a pathetic annual rate of 3.4 per cent – just a bit more than half what's "normal".

Get the point? The ups and downs of our mineral export prices shouldn't have any direct effect on the growth in government spending (though the boost to tax collections may have encouraged governments to be more generous on the spending side).

So the resources boom has had the effect of causing the government spending-to-GDP ratio to understate the extent of the growth in spending during the boom years, but now is overstating it.

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