Saturday, August 13, 2016

What's been happening to the distribution of our income

The single best explanation for the rise of Mr Crazy, Donald Trump, is that over the four years to 2013, the real income of the top 1 per cent of American households rose by 17.4 per cent, while that of the bottom 99 per cent rose by 0.7 per cent, giving the top few 85 per cent of the growth.

Another country where the gap between high and low incomes has widened markedly is Britain. And what crazy thing have the Brit voters just gone and done? You remember.

I think it's a case of what physiotherapists call "referred pain" - what you feel in some part of your body is actually coming from a problem somewhere else.

Many voters are conscious that their income doesn't seem to be growing and know something's badly wrong. But they don't join the dots the way an economist would.

They look around for something or someone to blame. They turn against their political leaders, who are "out of touch". Which they may well be.

But, as has happened many, many times before, voters also focus their resentment on the new migrants around them, especially those of a different race or creed. These people are taking all the jobs (especially those the local don't want), or they're all unemployed and getting too much help from the government.

Australia, it turns out, has also been acting strangely of late, turning against mainstream politicians on both sides, voting for populist protectionists like the Xenophones​ and resurrecting Pauline Hanson and One Nation, with new improved conspiracy theories.

So what's been happening to the gap between the top and the bottom in Oz? It's been widening but, fortunately, not nearly as quickly as in the US or Britain.

The Bureau of Statistics conducts a survey of the distribution of disposable income (that is, after allowing for income tax paid and welfare benefits received) between households. It's conducted every two years and the latest was for 2013-14.

Household disposable income that year averaged $998 a week, but with households in the lowest quintile (20 per cent block) getting $375 and those in the highest quintile, $2037 a week.

It's obvious that, if income were distributed equally between all households, each 20 per cent block of households would get 20 per cent of the total income of households.

In fact, the lowest quintile's share of total income in 2013-14 was less than 8 per cent. The share of the middle quintile (those households between 10 percentage points below the median and 10 points above it) was 17 per cent.

But the highest quintile's share was 41 per cent - more than twice what they'd get if income was distributed equally.

That's proof of the wide gap between high and low incomes in Australia.  It puts us above the average for income inequality among the member countries of the Organisation for Economic Co-operation and Development.

Even so, the bureau's figures show no significant worsening over the six years between 2007-08 and 2013-14 - the longest period in which its surveys can be compared on a consistent basis.

The most commonly used measure of the degree of inequality between households is the Gini coefficient - a scale running from 0, where income is equal between all households, to 1, where one household has all the income.

Our Gini was 0.34 in 2007-08 and 0.33 in 2013-14. You could call this a slight improvement, but I wouldn't - the change is too small to be taken literally.

Does that lack of change surprise you? It does me, especially as the Gini fell a little in the surveys of 2009-10 and 2011-12, before rising again in 2013-14. Huh?

Our base year of 2007-08 came just before the global financial crisis of September 2008.

Professor Peter Whiteford, of the Crawford School of Public Policy at the Australian National University, thinks the initial decline was caused by the Rudd government's big discretionary increase in pensions in 2009 and, on the other hand, the big fall in the sharemarket, which would have cut the incomes of higher income-earners.

Recessions usually hit the bottom of the distribution as well as the top by greatly increasing unemployment. But not this time because of the Rudd government's quick response and because the downturn's causes came more from the financial side of the economy.

Whiteford thinks the Gini's return to a more usual level in the latest survey is explained by the slow rise in unemployment in more recent years and the sharemarket's recovery.

But the stats bureau's practice of presenting the income distribution in quintiles tends to conceal an important development: the way income at the very top is growing much faster than it is even for people not that far from the top.

Economics professor-turned-politician Dr Andrew Leigh worked with one of the world's top experts in this field, British economist Sir Tony Atkinson, to develop a time series of movements in high incomes, based on data from the Australian Taxation Office. Leigh has handed it over to Professor Roger Wilkins, of the Melbourne Institute.

Wilkins' series shows that, between 1989 and 2013, the share of total individuals' income gained by the top 10 per cent of income-earners rose by 5 percentage points to more than 33 per cent.

But the top 5 per cent captured almost all of that increase. And the top 1 per cent claimed well over half the increase in the share of the top 5 per cent.

The top 1 per cent's share of total individuals' income is now 9 per cent. That is, their incomes average nine times what they'd be if incomes were equal.

Fortunately, this isn't nearly as extreme as it is in the US, or even Britain. But it does show Australia is moving down the same road as the others, suggesting the causes are international: technological change and globalisation.

Wednesday, August 10, 2016

Why much success comes with a slice of good luck

How important is luck in monetary success? A lot more than a lot of successful people are willing to admit – even to themselves.

Is luck as important as hard work in becoming successful? No – but, in the end, yes.

These are important questions – we ponder them often – that economists rarely bother to study. Except for one of my favourite economists, Robert Frank, of Cornell University in upstate New York. His new book is Success and Luck: Good fortune and the myth of meritocracy.

The case for believing that success is due overwhelmingly to talent and hard work – something every successful person wants to believe – is simple. Leaving aside a few lottery winners and rich heirs, almost every materially successful person is someone with ability who's worked hard for what they've got.

But the weakness in that argument is equally apparent: the many talented and hard-working people who haven't amassed much wealth.

What separates the two groups is good fortune. Some talented and hard-working people have enjoyed the additional benefit of a lucky break or two, some haven't, or have suffered unmerited setbacks of one kind or another.

Some have had the good fortune simply to have avoided any misfortune. And, of course, there are talented, hardworking, lucky people who aren't all that outwardly successful because they haven't given material success a high priority. (Don't bother feeling sorry for them – they've probably enjoyed far more personal satisfaction than those who measure their worth in dollars.)

It's easy for us to forget how much our success is owed to good luck. Everyone living has been born into the world at its most prosperous point. Everyone born in Australia starts with an enormous advantage over most other people in the world, in terms of free schooling and healthcare, freedom to choose their own path and freedom from predation.

When we joke about the importance of choosing the right parents, we acknowledge the role of inheritance in influencing future success.

Even when our parents have no great wealth to pass on, a big part of intelligence is inherited and academic success is greatly influenced by whether your parents were readers and valued education.

I've long believed that the example set by parents produces hardworking children.

Frank has no desire to undervalue talent or discourage hard work. Of course they play a major part in success. Nor is he opposed to meritocracy, where jobs go to the most able candidate.

His point is just that, for success, talent and hard work are, as they say at university, "necessary but not sufficient". Those who "got there on merit" shouldn't forget the lucky breaks they've had.

"Chance events are more likely to be decisive in any competition as the number of contestants increases," Frank argues. That's because winning a competition with a large number of contestants requires that almost everything goes right.

This, in turn, means that even when luck counts for only a trivial part of overall performance, there's rarely a winner who wasn't also very lucky.

In the topical case of athletics, luck can come in the form of wind. It would be stupid to deny that anyone winning a world record in the 100 metres, the 100-metre hurdles, the long jump or the triple jump was both physically gifted and had done years of training.

But Frank notes that of the eight current world records (men's and women's) seven occurred in the presence of a tailwind and none with a headwind.

To show the importance of luck even when it's only a small factor, he uses a computer to conduct a numerical simulation.

Say there are 100,000 participants in a contest where luck counts for just 2 per cent of performance, with ability counting for 49 per cent and effort for 49 per cent. For each contestant, the computer draws a number at random separately for each of the three components of their total performance.

The computer repeated this game many times (just as repeated tossing of a coin brings the result closer to 50/50).

The average luck score of the winners was 90 out of 100. And 78 per cent of winners did not have the highest combined ability and effort scores.

But if luck plays such an important role in success, why do the successful so often want to deny it? Frank offers two explanations, one charitable and one not.

We downplay the role of luck so as to motivate ourselves to try hard. When I wish Year 12 economics students good luck in the exams, I sometimes add: "You know how to be lucky? Make your own. The harder you work, the better your luck."

But there's often another, less worthy reason for denying our debt to good fortune. We use it to sanctify our wealth and justify our reluctance to pay high rates of income tax.

I'm well off because I made the right choices, studied when I could have played, saved when I could have spent and worked damn hard. Those people in the outer suburbs are poor because they didn't work and sacrifice the way I did.

I earned all I've got and it's quite unfair to tax me extra to give handouts to people who're too lazy or undisciplined to do what I've done.

That's why it's so important for successful people to acknowledge their good fortune.

Monday, August 8, 2016

Why the era of reform has ended

In case you haven't noticed, you're staring at the end of the era of economic reform. It has ended because it's come to be seen by many voters as no more than a cover for advancing the interests of the rich and powerful at their expense.

The evidence that the jig is up is all around us, in Brexit, Donald Trump and, at home, the near defeat of a government that went to the election with just one substantive proposal - to phase down the rate of company tax - which it sought to hide behind the empty slogan of "jobs and growth".

In the Senate we've seen the rise of the protectionist Xenophones​ and the resurrection of One Nation in even madder form.

To call the end of the reform era is not deny we'll still see the occasional policy proposal worthy of that name - such as Malcolm Turnbull's highly desirable changes to superannuation tax concessions and Labor's plan to curb negative gearing and reduce the capital gains tax discount.

But these have become exceptional events, hidden among the more numerous proposals to disguise rent-seeking as reform.

The economic reform era began in the early 1980s with Maggie Thatcher, Ronald Reagan and, of course, the Hawke-Keating government.

Many of those early reforms were unavoidable and greatly beneficial. America's airline deregulation brought an end to the cosseted flag-carriers and their unaffordable fares. Britain needed to end nationalised coal mines and other inefficiencies.

In Australia, we needed to open up our economy to the reality of a globalising world: to deregulate an inefficient and expensive financial system, float the dollar, phase out protection and move from centralised wage-fixing to collective bargaining.

But from such a promising start, now it's over. What brought the era to its ignominious end? Its noble goals were lost as it was hijacked by faulty ideology and vested interests.

The sceptical approach towards government intervention of the otherwise naive economists promoting reform left them susceptible to the smaller-government ideology - the belief that the private sector always does things better than the public sector, that government does too much and taxes are always too high.

This made them sitting ducks for the greedy rich - who cloak their greed in "libertarianism", while actually resenting being asked to subsidise the poor via taxation.

Economists were also the dupes of business people anxious to find ways of increasing their profits easier than the hard graft of price competition and struggling for market share.

They happily turned the provision of government services over to private firms. It never occurred to them that the private providers might cut corners on quality, exploit the naivety of public officials, find a way to get at the pollies, or lose all sense of restraint in their efforts to rip money out of the public purse.

After the long list of disasters in the field of outsourcing - the great private childcare collapse, the exploitation of foreign students by firms selling phony courses in return for permanent residence, the fly-by-night pink batt installers, and the near destruction of TAFE - the punters can tell something's badly wrong.

An early area of outsourcing was the replacement of the Commonwealth Employment Service with a network of charitable and for-profit providers of "employment services". Just wait for its inadequacies to be exposed when next we suffer a severe recession.

The outsourced provision of aged care is likely to be an ever increasing headache for governments.

Then there's privatisation, where too often governments have sacrificed the reformist ideal of increasing competition to increase efficiency on the altar of using existing or newly created monopoly power to enhance the sale price.

Why maximise sale price at the expense of consumers? Because of the obsession with debt levels and maintaining credit ratings. Faced with a choice between efficiency and the budget deficit, too many state treasuries have looked the other way.

A win for accountants over economists.

But the reformers' greatest failing has been the conceit that they look after efficiency and leave equity to lesser mortals: they ignore their reforms' effect on fairness.

At a time when technological change and globalisation are shifting the distribution of market income in favour of the top few per cent of earners, they're pushing "reforms" to make the tax system less redistributive.

And the very reformers who want freedom for some industries to expand while others contract have been happy to allow the rate of unemployment benefits to fall to almost a third below the poverty line.

Then they wonder why the punters decide something is badly off-beam and turn to soothsayers and medicine men.

Saturday, August 6, 2016

Why cut interest rates again? It's the exchange rate, stupid

The trouble with the Reserve Bank's continuing cuts in the official interest rate – this week to another record low, of 1.5 per cent – is that it could leave people thinking the economy's in bad shape.

It isn't. As Reserve governor Glenn Stevens was at pains to point out, recent figures suggest that "overall [economic] growth is continuing at a moderate pace" notwithstanding a very large decline in investment in new mines and natural gas facilities.

In consequence, employment is increasing and unemployment is, as they say in the financial markets, “flat to down”.

It's not brilliant, but it's not bad. Our economy is growing faster than most other developed economies. Nor is it expected to slow.

In which case, why is the Reserve cutting interest rates? Good question. Actually, it says more about the trouble other rich countries are having getting their economies moving than it does about ours.

The advanced economies – even the Americans – have still not recovered properly from the Great Recession precipitated by the global financial crisis of 2008.

The long boom that preceded the crisis involved a lot of borrowing by banks, businesses and households, partly to bolster living standards, but also to buy housing, commercial property and other assets.

When, inevitably, the credit-fuelled boom busted and asset prices fell back to earth, a lot of households and businesses were left with assets whose value no longer exceeded their liabilities.

Recessions that arise from such "balance sheet" problems always take a long time to recover from, as households and businesses cut their spending and investing in order to pay off their debts.

That was bad enough. But the difficulties were compounded by governments on both sides of the North Atlantic convincing themselves the problem wasn't excessive private sector borrowing, but government borrowing.

They not merely concluded they should do no further deficit spending, they embarked on the deeply misguided policy of "austerity", in which they tried to cut government spending and raise taxes at a time when the economy was already weak. Unsurprisingly, they made little progress in reducing deficits and debt.

This foolish fashion of forswearing the use of fiscal policy (the budget) to increase public sector demand at a time when private demand was weak threw all the task of restoring the economy's growth onto monetary policy.

From a position in most North Atlantic economies where official interest rates were already quite low, central banks cut their rates almost to zero.

When this did little to boost demand they resorted to the unconventional policy of "quantitative easing" – they bought bonds from banks with money they created with the stroke of a pen.

This was intended to lower long-term bond rates, which it did. But it did more to push up the prices of financial assets than to encourage increased spending in the real economy.

With QE doing little to help, some European central banks have even moved to negative interest rates – actually charging lenders a tiny percentage for borrowing their money.

If this sounds increasingly crazy, it is. But it's the world we and our central bank have to live in.

Historically, monetary policy was designed to keep inflation low. But it's a long time since many countries had to worry about high inflation. These days more of them worry about the opposite problem of "deflation" – continuously falling prices.

We, too, have very low inflation: an underlying rate of 1.5 per cent, compared with the Reserve's target range of 2 to 3 per cent.

This situation has led some to conclude the Reserve's reason for cutting the official rate this week was to help get the economy growing a lot faster, so inflation pressures would build and get the inflation rate back into the target zone.

That would make sense in normal times, but times aren't normal. Nor do I imagine the Reserve thinks a cut of another 0.25 percentage points (and less for people with mortgages) will make much difference to the strength of borrowing and spending.

So why did the Reserve feel it needed to cut by another notch? My guess is it had more to do with trying to reduce upward pressure on the dollar – our exchange rate.

The biggest effect of QE – creating more of a country's currency – has been to put downward pressure on that country's exchange rate. Meaning, of course, upward pressure on other countries' exchange rates – including ours.

Our dollar soared during the resources boom when the world was paying extraordinary prices for our coal and iron ore. It dropped back when commodity prices fell, but its return to more comfortable levels for our export and import-competing industries was impeded particularly by the Americans' resort to QE.

It eventually got down to the low US70¢s and the Reserve regards a lower dollar as a key element, along with low interest rates, in stimulating faster growth in our production of goods and services.

Of late, however, the dollar has drifted back up to about US76¢, which the Reserve regards as a retrograde step.

Get this: contrary to the easy assumption of some people, there's no simple, mechanical relationship between the level of our interest rates (or, strictly, the difference between our rates and those offered by big players such as the Americans) and the level of our exchange rate.

Even so, with no inflation problem in sight – and, indeed, with any fall in expected inflation leading to a rise in our real interest rate – the Reserve decided to err on the safe side by trying to reduce upward pressure on the dollar.

So why did the Reserve cut rates? It's the exchange rate, stupid.

Wednesday, August 3, 2016

Fast-moving China is big and bold; we think small and fearful

Sorry if I sound wide-eyed, but I was mightily impressed when I visited China as a guest of the Australia-China Relations Institute. Obviously, we were directed to the best rather than the worst but, even allowing for that, it was still impressive. Those guys are going places.

In a hurry. I was struck by how fast-moving the place is – in several senses. We argue interminably about getting a high-speed rail link, while the Chinese just get on with it.

We took the bullet train from Beijing to its nearest port, Tianjin, 140 kilometres away. So smooth you didn't really notice how fast it was going.

The government-run China Daily announced while we were there the plan to have 30,000 kilometres of high-speed track built by 2020. You could be sceptical – except they already have 19,000 kilometres installed.

Tianjin, admittedly a city of 11 million, has the newest, fanciest, most cavernous cultural centre and municipal buildings I've seen. I tried not to wonder how much it all cost and where the money had come from.

So many of us have outdated perceptions about China. It's a poor country producing cheap clothes and toys and knick-knacks in sweat shops.

That used to be true, and in parts of the country still is. But these days China is a middle-income country anxious to get rich gloriously.

In the Tianjin free trade zone is a factory for the European-owned Airbus. All the jetliners it produces are sold in China.

Of course, we tell ourselves, any technology they use has come from foreigners, sometimes without proper recompense.

Don't be so sure. We visited Shenzhen which, until 36 years ago, was a fishing village just across the water from Hong Kong, before someone made it a special economic zone.

I remember visiting it in January 1984 on a tourists' day-trip from Hong Kong. It was a dusty country town with a big new hotel for foreign visitors and a few factories, plus stalls selling stuff to tourists. I bought a Chairman Mao cap with a red metal star.

Today it's a city of 10 million, with income per person of about $29,000 a year. It has maintained 45 per cent of its area as parks and forest by the simple expedient of having housing go up rather than out.

It still has some low-end manufacturers, but they're being encouraged to move inland or to some south-east Asian country, such as Vietnam.

Land and wages in Shenzhen are too expensive for low-value production. Last year in China consumer prices rose by 2 per cent, while the average wage rose by 8 per cent.

So manufacturing in Shenzhen is moving to the high-tech end and the services sector now accounts for 60 per cent of its economy.

Its businesses put huge sums into research and development. In 2014 R&D spending accounted for 4 per cent of Shenzhen's gross domestic product. In Oz it's about half that.

BYD – standing for Build Your Dreams – is a private company founded in the city in 1995. It started out making batteries for mobile phones, but is now well advanced with the research and development needed to fulfil its "three green dreams" of making solar farms, travelling renewable energy storage stations, and electric vehicles.

It still makes and sells conventional cars, but is more interested in its range of hybrid and pure electric cars and buses. It's best known in Australia for its electric forklifts.

Many Chinese cities seek to reduce pollution by capping the number of new cars they'll register each year. Buy a hybrid or electric car, however, and you avoid the lottery.

Buy an electric SUV and the government gives you a subsidy of about $27,000, reducing the price of BYD's model to $47,000. The subsidy will be phased out as the company gains economies of scale.

Before moving to Shenzhen, BGI began life in 1999 as the Beijing Genomics Institute. It's now one of the world's largest genomic institutes, using gene sequencing to develop antenatal tests for genetic abnormalities and to detect diseases earlier.

In agriculture it's using genetic assisted breeding (not genetic modification) to develop better strains of fish and millet – a grain widely consumed in China.

It has more than 800 scientists working for it, and a wall showing the many covers of the journals Science and Nature celebrating its notable discoveries.

Huawei was founded in Shenzhen in 1987 by Ren Zhengfei, a former engineer in the People's Liberation Army. It started as a manufacturer of office PABX phone systems, but is now the largest telecommunications equipment manufacturer in the world.

It ploughs a minimum of 10 per cent of its revenue back into research and development, spending about $12 billion last year. The company is staff owned, with Ren's share down to 1.4 per cent.

It has installed Australia's largest private 4G communications network for Santos' mining operations.

In China it helped the Shenhua coal company raise the capacity of its Shuo Huang railway to 200 million tonnes a year. Its 4G system permitting synchronous control of multiple locos allows single train lengths up to 3000 metres long, carrying up to 20,000 tonnes.

China is big; we think of ourselves as small. China is confident, impatiently pushing towards a better future; we are fearful, waiting for more luck to turn up.

Monday, August 1, 2016

China plans big expansion of trade - without us

You've heard of belt and braces. You may even have heard of one country, two systems. But have you heard of One Belt, One Road? No, I thought not. Rest assured, you will.

It's a topic much discussed in business and economic circles in China, as I learnt on a visit there sponsored by the Australia-China Relations Institute at the University of Technology, Sydney.

It's a plan for the establishment of a new Silk Road between Europe and China, to increase trade and cultural exchange between all the countries along the route.

It's an initiative of the Chinese government, first announced by President Xi Jinping​ in 2013, and much elaborated since then.

The belt refers a land-based Silk Road Economic Belt running through China to Central Asia to Russia and Europe.

The road refers to a sea-based Maritime Silk Road taking in the countries of south-east Asia and running through the Indian Ocean to the countries of South Asia, then through the Suez Canal to the Mediterranean.

To keep muddling metaphors, the maritime "road" may even have a spur line to Africa. In principle, more than 60 countries could be involved.

It may sound like a politicians' grand vision that won't get far. That's certainly the way some American critics have reacted to it. There could be much suspicion, resentment and resistance to China's expansion plans from countries and their citizens, they say.

But while pollies talk big in Western countries, in China they tend to act big. Making the initiative a reality would involve much spending on infrastructure such as sea ports, airports, railways, highways, oil and gas pipelines, power stations and special economic zones.

China has much to gain from all this, of course. Its existing development activity in certain African countries suggests it would supply much of the materials and labour for infrastructure projects.

Should the oft-predicted economic "hard landing" eventuate and lead to rapidly rising unemployment at home, its desire to get on with foreign construction projects might be heightened.

Establishing a new Silk Road means China, already the world's largest trading nation, would greatly expand its export opportunities.

But trade between a willing buyer and willing seller is mutually beneficial. And increased trade could do much to hasten the economic development of the "stans" of Central Asia - such as Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan.

Already there is much interest and activity in Pakistan.

Geoff Raby, a former Australian ambassador to China, has observed that the initiative is "of great strategic significance for Beijing, as it is also intended to reduce China's major strategic vulnerability caused by so much of its seaborne trade, especially crude oil, having to go through the Strait of Malacca".

As an aside, this vulnerability also helps explain China's sensitivity over the South China Sea.

Full implementation of the initiative could take decades, of course. But a solid start has already been made. For instance, a freight rail link between the south-western China province of Sichuan (the one with the spicy food) and Lodz in Poland is now running three trains a week.

This fits also with the Chinese government's earlier - and continuing - Go West campaign to move economic activity - particularly labour-intensive manufacturing - inland from the richer coastal provinces, where labour is getting ever-more expensive.

But have you noticed something? The many countries that could get involved with the initiative include Indonesia, but not us.

At least, not directly. There is scope, however, for Australian banks and other financial institutions help facilitate the funding of infrastructure projects.

Much of the construction of projects will be done by big Chinese state-owned enterprises. We could, of course, sit back and hope this leads to restored demand for our coal and iron ore.

But the SOEs will often need to partner with foreign firms able to provide the specialist expertise they lack in in such things as engineering and major construction.

Many Australian companies are well-equipped to supply such consulting services, but to-date our firms have shown limited appetite for the higher risks involved in developing country projects.

Much safer to limit your innovation and agility to pressing the government for "reforms" that cut the tax you pay or allow you to drive harder bargains with your employees.

But not to worry. There are Japanese and South Korean firms who'll be happy to eat the Chinese lunch we don't fancy.

Saturday, July 30, 2016

China does its own thing in its own way

On the prospects for China's economy, it's easy to be wrong. We analyse unfamiliar things by comparing them with things we understand, but in its massive size and economic history, China is one of a kind.

That's one conclusion I've drawn from a visit to China as a guest of the Australia-China Relations Institute, at the University of Technology, Sydney, and the All-China Journalists Association.

In recent years people in the world's financial markets have gone from ignoring the Chinese economy to assuming it works the same way a developed economy does.

Hence the consternation in global share markets last year and again early this year when China's share market took a sharp dive. Surely this meant its economy was in big trouble.

Well, maybe, but not for that reason. China is still a developing, middle-income economy and its share market is a relatively recent creation of its government, lacking the strong links with the real economy we're used to in the West.

As Professor Peter Drysdale, of the East Asian Bureau of Economic Research at the Australian National University, has explained, the worth of China's share market is equivalent to about a third of its gross domestic product, compared with more than 100 per cent in developed economies.

It accounts for less than 15 per cent of the financial assets of China's households, which is why formerly booming share prices did little to boost consumer spending and why falling prices will do little to hurt consumption, he says.

The market is dominated by individual investors rather than financial institutions, as in the rich world, and Chinese companies don't rely on it for capital-raising.

Much of the angst in the West over China's slowing rate of growth – from 10 per cent a year for many years to 6.7 per cent over the year to June – reveals an ignorance of how developing countries develop.

Provided they're well managed, it's easy for underdeveloped economies to grow rapidly as workers move from the farm to a city factory and as existing Western technology is taken off the shelf and applied.

But as the economy expands it becomes harder and then impossible to maintain such high rates of expansion.

China's less dramatic growth rate of six point something is now "the new normal", as its government says. Further slowing is possible in the next few years.

We in the developed world – where growth rarely gets much higher than 2 or 3 per cent a year – are so unfamiliar with such rapid growth rates that we forget the basic arithmetic involved.

At a constant growth rate of 10 per cent, an economy doubles in about seven years. At a constant rate of 6.7 per cent, it doubles in about 10.

Consider this: China's growth in 2005 of 11.3 per cent added $US338 billion to its size, whereas growth of 7.4 per cent in 2014 added $US708 billion. It's the absolute size of China's growth – its addition to gross world product – that matters most to the rest of the world.

Another trap for foreign observers is to assume China has a market economy like ours, or that the Chinese government is busy turning its economy into a market economy.

That's easy to believe when you're told that, in 2014, China's private sector produced at least two-thirds of its GDP, with the private sector creating more than 90 per cent of the additional jobs and with the public sector accounting for just 11 per cent of China's workforce (compared with 14 per cent in Oz).

But China's economy is still far from being a market economy like ours, and it's not clear the Chinese government wants to make it one.

Remember China's history. In the 1950s, following the Communist revolution of 1949, private property was expropriated and a planned economy established.

All that began changing after 1979, when Deng Xiaoping initiated the far-reaching market-oriented reforms that have brought China's economy to where it is today.

China's many remaining state-owned enterprises may not be as dynamic and fast-growing as its private sector, but they remain an important part of the economy. Indeed, they're a drag on the economy, often badly run with problems of overcapacity and overproduction.

Many foreign economists are urging China to simply close or privatise its remaining SOEs. And it's true that reforming them would be an important part of raising China's productivity performance.

But it's not clear this is the intention of China's President (and general secretary of the Communist Party), Xi Jinping. Some degree of reform may come, but it may involve adopting market mechanisms where thought appropriate rather than eliminating the government-owned business sector.

Making China's economy the same as any Western developed economy is unlikely to be Xi's objective, even if the pressure of events causes it to continue drifting in that direction.

China remains a one-party state, and the objective of that party is to remain in power. That may mean reforming rather than eliminating SOEs, which are run by party officials.

Within the Chinese government, power is shared between the central, provincial and municipal governments, all of them run by party officials. Beijing's power is constrained.

Xi is unlikely to initiate any big changes before the Communist Party's 19th national congress late next year, when he will be able to increase his grip on power.

Economic reform and year-to-year economic management is guided by the 13th five-year plan. Growth in GDP is not just a measure of economic success, it's a political target.

Most Westerners believe continuing economic development and rising living standards lead inevitably to democratic governance, and the cases of Taiwan and South Korea add support to this idea.

But whether that applies to China remains to be seen. Certainly, it's a long way off. The safest prediction is that China will do its own thing in its own way.

Monday, July 18, 2016

Liberals ignore the moderate middle at their peril

It's amazing to realise that the greatest threat to the success of the Turnbull government comes from the Liberal Party. Malcolm Turnbull's biggest enemies are inside his own government, not outside.

If he's to make sufficient progress with controlling the budget and reforming the economy to warrant re-election in three years' time, he needs to mix budget restraint with fairness, and combine efficiency with equity.

This, after all, was the formula the Hawke-Keating government used to stay in government for 13 years, despite all the things it did to get the budget back to surplus after the deep recession of the early 1980s and all the controversial reforms it made to open up the economy.

Remember that the people with the most reservations about those reforms – deregulating the banks, floating the dollar, removing protection – were its own supporters.

Only much later did Labor's true believers adopt Paul Keating as one of their heroes. And it was only by making uncharacteristic changes that Hawke-Keating came to be remembered as one of our greatest governments.

The people making trouble for Turnbull within the Liberals seem to have learnt none of that. They haven't even learnt the lesson of their latest near-death experience: low and middle income-earners won't vote for you in sufficient numbers if they suspect you don't represent their interests.

It's much easier to argue that Turnbull lost votes because his party had pushed him too far to the right than because he wasn't as far to the right as a noisy minority thought he should be.

Turnbull lost votes partly because, to get the party's permission to rescue it from certain defeat under Tony Abbott, he had to agree to leave untouched various extreme policies the whole country knew he didn't believe in.

Labor's Medi-scare was effective because Abbott's attempt to dismantle bulk-billing with his $7 co-payment exposed the party's lifelong antipathy to Medicare that a chastened and wiser John Howard had cloaked with his claim that the Libs were the best friend Medicare ever had.

Turnbull's policy for the reform of superannuation tax concessions was the epitome of the carefully balanced policies we need more of if we're to have reform without fear of electoral defeat.

It was a micro reform in that it reduced the tax system's distortion of saving choices, and it will contribute significantly to reducing the budget deficit, but do so in a way that reduces the concession to the undeserving well-off (including me) while making the scheme fairer to low income-earners and women.

And yet the Liberal dissidents' greatest push is to modify the super reforms in favour of a relative handful of high-flyers. If Turnbull – and the more moderate, sensible elements of the parliamentary party – let this push succeed there could be no better demonstration of the party's instability and its continuing commitment to governing in favour of its well-off cronies, not ordinary voters.

The first rule of Australian politics is that Aussies won't vote for extreme parties. That's why, over the decades, both sides have moved towards the middle ground.

But it's remarkable to realise that, while Labor has been working hard to house-train its left wing, the Libs have been drifting further to the right, allowing extremists to dominate its state branches and more and more hard-liners to be elected to the parliamentary party.

Although the pragmatist faction still has most adherents in Parliament, much of the party is now out of step with the community on social issues and obsessed with furthering the economic interests of the well-off, not the punters.

Too many in the party have become self-indulgent and inward-looking. Let's play favourites between Tony and Malcolm. Let's let the old men continue blocking the talented young and the female. Let's make the party utterly unattractive to the younger generation.

In short, too many in the party have lost touch with electoral reality. In this they've been led astray by noisiness of their media cheer squad and the libertarian think-tanks. The Murdoch press has yet again demonstrated its inability to deliver the tabloid voter.

In this election the Coalition stuck its neck out by making an unpopular cut in company tax its main policy proposal. And yet big business seems to have failed to offer much support in the way of donations.

If that doesn't give the Liberals pause for thought, nothing will. Apparently, big business thinks itself so virtuous – so synonymous with the nation's interests – that even the Libs owe it a living.


Saturday, July 16, 2016

Government outsourcing has many pitfalls

Labor's Mediscare will have a benefit if it causes our politicians to think twice before they resort to "outsourcing" or "contracting out" the provision of government services, a practice that's led to a string of disasters.

The pretext for Labor's claim that the Coalition was planning to "privatise" Medicare was the Turnbull government's intention to save a little money by shifting the processing of Medicare's many bank transfers from its giant cheque-writing agency, the Department of Human Services, to a private provider.

We wouldn't even have noticed this back-office switch, but Malcolm Turnbull felt obliged to swear the proposal would be abandoned.

This probably means he'll also have to give up any thought of outsourcing all the many other, pension, allowance and benefit payments the department makes.

One reason for doing so was that the department's computer system is old and clunky and needing to be replaced – a prospect that always seems to frighten governments, especially those trying to keep their budget deficit low by postponing needed asset replacement.

Since polls show the public is strongly opposed to all privatisation, it's not hard to imagine most voters wouldn't like the sound of outsourcing.

But if this realisation comes as a surprise to the Coalition, it may also be a caution to Labor, which over the years has also engaged in much outsourcing.

Much of it has gone on, at state and federal level. When a woman rang me the other day to do a government security check on someone I'd worked with, I was surprised to hear she worked, not for ASIO, but for a Canberra company called Key Vetting Services.

In principle, it's very simple. You call for tenders and if a private outfit can do the job more cheaply than your public servants can, you give it the job.

In practice, it's never simple. For a start, you can't be sure that what we're assured is saving the taxpayer money really is, once you measure it properly.

For instance, one of the ways federal and state governments seek to retain their AAA credit ratings is by using "public/private partnership" agreements to have the borrowing for motorways and other big projects done by some private enterprise. This way, the debt appears on its balance sheet rather than the government's.

Small problem: hiding the government's debt in this way ends up being far more costly to taxpayers. The oh-so-holy credit rating agencies turn a blind eye.

Federal and state departments spend a fortune each year on private sector consultancies. It's possible this saves money.

But it's also possible it was done to get around some directive to reduce staff numbers and is actually more expensive. Or maybe they got rid of people they later realised they couldn't do without, and had to pay top dollar to get 'em back.

Another dubious scheme is the sale and lease-back of government offices. The budget deficit takes a big dip in the year you sell the office off, but is worsened in subsequent years by the big rents you now pay.

These schemes are notorious for the outrageously good deals used to entice private sector players to take up the properties and rent them back.

A related version of outsourcing follows the notion that the provision of government services should be made "contestable". Services normally provided by government agencies or by non-profit community groups are opened up to for-profit providers.

Successive governments have done this with Job Services Australia, childcare centres and vocational education and training. The pink batts scheme was left entirely to for-profit providers.

With childcare, the government let one aggressive provider, ABC Learning, take over more than half the nation's centres before collapsing, at great inconvenience to parents and expense to taxpayers.

The disaster from the outsourcing of VET – again, federal and state – is still being cleaned up. The loss of future trained workers may hurt the economy for years.

Many people assume the private sector will always do things more efficiently – or less inefficiently – than those tea-drinking public servants.

Maybe. The private sector has a big advantage over the public sector: it has just one objective, to make a buck.

But what those who think this way often forget is that private sector tenderers have to undercut the public service's price and make room for their profit, which they hope to make as big as possible.

Often they do this by cutting corners on the quality of the service they deliver. Leave a loophole in your contract and they'll jump right through.

The public sector's big disadvantage is also its big advantage: it always has a range of objectives, imposed on it by politicians who know that voters will hold them responsible should the service prove really bad.

And here's a point you won't find in any textbook, but all the stuff-ups of recent years should have woken us up to: when you give businesses access to the government's coffers, a surprisingly high proportion of them lose all sense and start acting like robbers in Aladdin's cave.

Witness: all the unsafe behaviour by outfits trying to make a killing in the pink-batt boom; all the operators using inducements to sign up students for unsuitable courses, the costs of which were borrowed from the government; all the operators using the lure of permanent residence to rip off foreign students with phoney courses.

I also suspect that, for the Coalition, there's an additional, political motive: outsourcing some government service shifts economic activity to private enterprise, the part of the economy whose interests the Coalition champions, and to the people who are your friends and donors.

If so, why does outsourcing also need to save the taxpayer money?

The Turnbull government's intention to implement the Harper competition report's proposal for greater contestability in the delivery of "human services" is now likely to be approached with caution. No bad thing.

Wednesday, July 13, 2016

Election result need not be a setback for good government

Maybe those who complain about a boring election campaign are condemned to an exciting election finish. Many in the establishment – particularly the business establishment – have convinced themselves the country is off to hell in a handcart, but it doesn't have to be like that.

The nation won't be ungovernable provided Malcolm Turnbull is willing to negotiate with the minor parties when necessary – hardly a new experience for governments, which rarely have a majority in the Senate.

Nor does it follow that the government will be unable to hasten the budget's return to surplus.

As a study by the Australia Institute has demonstrated, much of this year's budget can be legislated, particularly with a little compromise.

In any case, the budget is not the economy. And, contrary to any casual impression you may have absorbed, the prospects for the economy remain reasonable.

Brexit is bad news for the Brits, and adds to Europe's many problems, but it's not big enough to greatly affect the rest of us. The US economy is gathering speed.

The messy election result won't have much effect on the economy. Business loves whingeing about "uncertainty" – when it's got nothing else to do or say, that's what it does – but the period of transition from the mining investment boom is getting towards its end and, as it does, the rest of business will be getting on with it.

The economy has been growing at a rate that's about average, and the best guess is it will continue doing so. It has been creating additional jobs and this should continue.

For all that, however, there are messages for politicians on both sides from this election. How well they listen will determine how well we are governed over the next three years.

(Don't fall for the one about how we'll be back to the polls in no time. The more-excitable always say that at times like this.)

The first message comes from the continuing decline in people voting for the major parties. The proportion of voters giving their first preference to a minor party reached almost one in four.

This is not surprising when you remember how standards of conduct have fallen: the broken promises, the scare campaigns, the negativity and automatic opposition to whatever the other side says, the statements that are true in some sense but have been crafted to mislead.

The plain fact is that the mainstream politicians have forfeited our trust and lost our respect.

Many of us have concluded they're all liars, and we tune out whenever they start slagging each other off, or arguing about who has the bigger hole in their costings. They could save themselves much energy if they learnt not to bother doing this.

The message for the government is that it must broaden its appeal if it wants to attract a comfortable majority of two-party-preferred vote.

Any lapse into infighting between Abbott and Turnbull supporters will be the final proof the Coalition is no different from Labor.

The Coalition campaigned on its plan for jobs and growth (which boiled down to a cut in the rate of company tax), while Labor campaigned on the public's worries about cuts to government spending on education and health.

Labor's success in this argument explains why it did so much better than expected.

The Coalition suffered from the lingering resentment and suspicion provoked by Tony Abbott's first budget, which attempted to fix the deficit almost solely through cuts to the spending on health, education and welfare depended on by low and middle income-earners, while protecting the earnings of businesses supplying services to government and the tax breaks enjoyed particularly by high income-earners.

Many of those measures were abandoned, though some remain "zombie measures", rejected by the Senate but still on the government's books.

The memory of that deal-breaker budget was kept alive by Scott Morrison's insistence that the budget had a spending problem, not a revenue problem. (Surely Turnbull will use this opportunity to find Morrison "a job to which you're better suited".)

The message for the Coalition is obvious: it must switch to budgeting for all Australians. That means tax increases as well as spending changes that seek genuine efficiencies in contracting with business suppliers (drug companies, for instance), not just cost-shifting to the public.

The message for Labor is that its strategy of not being as obstructionist towards the government as Abbott in opposition was towards it, and of making itself a big target in the election by proposing "positive policies" (such as limiting negative gearing), worked well.

So now is not the time to revert to Abbott-like spoiler behaviour – if I wreck the joint they'll have to give up and hand over to me.

When they combine, the two sides can get anything through the Senate. Labor can win itself voter respect for being sane and sensible without bowing to the government's every wish.

It can help with the compromises. And when the government's fighting the good fight against powerful interests (such as the two big pathology companies, and the Coalition greedies​ making spurious claims about retrospective super changes) it can resist the unworthy temptation to take advantage of it.

With Labor now hopeful of winning next time, any budget nasty it helps the government fix now will be a problem it won't have to fix then.

Monday, July 11, 2016

Oh no, not a credit rating downgrade

Sorry, but I've put Standard and Poor's and the two other big American credit rating agencies on a negative watch.

For me, the rating agencies' involvement in the global financial crisis has destroyed their credibility forever. I can no longer take their solemn pronouncements seriously, nor hear them with the reverence or contrition they imagine themselves entitled to.

The rating agencies were one of the private sector institutions charged with upholding standards of behaviour in America's financial markets, putting investors' interests ahead of their clients' and their own.

They were supposed to be a bastion against crisis and collapse, but they betrayed their trust.

The way their system works is that institutions wishing to borrow money by issuing bonds or other securities have to pay rating agencies to give those securities a rating of their credit worthiness.

The agencies' job pre-crisis was to be the hard-headed wise men who could see through the smoke and mirrors created by "innovators" on the make. They failed.

While everyone else in Wall Street was making money hand over fist, they didn't resist the temptation to get in for their cut.

They obliged their paying customers by awarding AAA credit ratings to securities subsequently exposed as "toxic debt".

In the process, they exposed the obvious conflict of interest involved in the common practice of governments attempting to protect the interests of investors and others by requiring businesses to buy "independent" certification from other businesses.

To an extent, governments around the world give the rating agencies a captive market by requiring certain organisations to hold only those securities certified as AAA.

This was how some Australian local councils got sucked into America's toxic debt crisis.

Trouble is, with this monumental blot on their record, we can no longer be sure what game the ratings agencies are playing and in whose interests they act.

In the case of government ("sovereign") borrowers, the agencies take it upon themselves to issue ratings. They then have the temerity to present the government with a bill for their services, though no self-respecting treasury pays up.

They seem to be pretty tough on government borrowers, though the lines they draw between safe and unsafe levels of debt seem pretty arbitrary.

What I wonder is if they have higher and holier standards for government than they have for their private sector fellows.

Why not? Everyone in business (and a lot of people in treasuries) know that governments, because their actions are not the product of market forces, are therefore non-rational and prone to being either mad or bad.

The agencies want us to believe their deliberations are highly scientific and sophisticated, applied consistently across the world.

But it's open to doubt how true that is.

After all, many of us believed the line that the whole towering edifice of ever-multiplying derivatives and synthetics built up before the financial crisis was the product of amazing advances in statistics and the science of finance, which had rendered us far smarter than we used to be at "managing risk".

When it comes to signalling changes in the riskiness of particular borrowers, the agencies purport to be the leaders: their vigilance causes them to be the first to see the problems looming, with the market following their lead.

But it's common for the market to turn against some borrower, leaving the agencies scrambling to adjust their ratings to fit. Are they just purveyors of conventional wisdom?

Whenever a downgrading of one of our governments is threatened, the media unfailingly assure us this would be a bad thing because the government would have to pay higher interest on its debt.

If this is still true, it's much less so than it used to be. And if there is still a premium to be paid, it's smaller than it's made to sound.

The rating agencies' loss of authority since the financial crisis is evident.

When, in 2011, in a rush of blood to the head – or maybe a touch of the megs​ – Standard and Poor's announced it had cut the US Government's credit rating to AA+, the other two did not follow suit and the market took not a blind bit of notice.

The yield (interest rate) on US Treasury bonds continued falling. Moral: don't try to get smart with the world's reserve currency.

But something similar happened when the three agencies downgraded Britain to AA- in the wake of the Brexit vote. Yields on British bonds have since fallen, along with those of other "sovereigns", including us.

Sometimes there are forces more powerful than a bunch of for-profit rating agencies.

Saturday, July 9, 2016

Workforce participation a key for Turnbull's new plan

Now it's likely the Turnbull government will scrape back to office, what's next? What will it do to improve our economic prospects?

Malcolm Turnbull went to the election offering a "national plan for jobs and growth" that was supposed to secure our future.

Trouble is, it now looks unlikely he'll be able to implement the centrepiece of that plan, the phased reduction over 10 years of the rate of company tax, from 30 per cent to 25 per cent.

Unsurprisingly, the proposed cut in company tax did not impress the voters, who think companies are paying too little tax, not too much.

Labor opposed the cut, save for the immediate reduction to 27.5 per cent for genuinely small business.

With the government now facing an even more hostile Senate, it's unlikely Turnbull will get any more than that.

This would be no great loss in the quest for jobs and growth. The government's own modelling suggested the tax cut would do virtually nothing to create jobs, and the boost to growth in Australians' incomes would be tiny and come only after a decade or three.

But what about the other parts of Turnbull's "five-point plan"? It's a muddle of things that will be done, things already done and a point saying what the plan will achieve.

Point one is "an innovation and science program bringing Australian ideas to market". Already done; benefits likely to be modest.

Point two is "a new defence industry plan that will secure an advanced defence manufacturing industry in Australia". Or a highly protectionist and costly way of buying votes in South Australia, of debatable defence value.

Point three is "export trade deals that will generate more than 19,000 export opportunities". This refers to preferential trade deals already made with Japan, Korea and China.

As my colleague Peter Martin has demonstrated, this is one of the big lies of the campaign. Such trade deals usually add more to our imports than our exports (which, of itself, is no bad thing).

Point four is the company tax cut and point five is "a strong new economy with more than 200,000 jobs to be created in 2016-17". This is just Treasury's budget forecast for growth in employment. Few of those extra jobs would have been "created" by anything the government did.

Get it? The "plan for jobs and growth" is a (now-thwarted) plan to cut company tax, plus a lot of packaging. That is, Malcolm Turnbull has no plan.

And, as we've been reminded by noises coming from one of the credit rating agencies, nor does he have a plan to get the government's budget back to surplus anytime soon.

His projection of that happening in 2020-21 relies heavily on a host of forecasts and assumptions.

Many people conflate the need for action to get the budget back to surplus with the need for "reform" to hasten our rate of productivity improvement and economic growth.

The two are related, of course, but they're not the same thing and we should consider them separately.

Remember that whereas productivity improvement is what you could call a "positive" objective, leaving us clearly better off materially, fixing the budget is a "negative" objective – it would just reduce the risk of problems down the track.

Obviously the longer we take to get back to balance, the more our interest bill grows. If this arises from borrowing to cover recurrent spending at a time when the economy is back to growing at about its trend rate, this is a bad thing.

However, if the borrowing is needed to cover spending on infrastructure (as you discover is largely the case when you study the information buried on page 6.17 of the budget papers) this is no cause for concern – provided the money hasn't been spent wastefully.

The cost of any credit rating downgrade is overrated, but it is true that, if we've got the budget back to surplus by the time we're hit by the next recession, we'll feel freer to respond as we should: allowing the downturn to push us back into deficit and adding temporary stimulus spending on the top.

Getting the budget back to surplus will do nothing to create "jobs and growth". Indeed, if you go about it the wrong way, it could come at the expense of jobs and growth.

A lesser-known point is that improvements in our productivity performance do little to improve the budget balance.

That's because it does about as much to increase government spending (directly and indirectly) on public sector wages and wage-indexed welfare payments, as it does to increase economy-wide wages and profits and, hence, tax collections.

As he casts about for a real plan to implement in the coming term, Turnbull should remember the thing that does help both the budget and Jobson Grothe: increased participation in the workforce.

This truth was lost when Turnbull was led astray by the rent-seeking of the Liberals' generous big business supporters and their obsession with cutting their own taxes in the name of "reform".

So one obvious place for Turnbull to start is with women. The Abbott government made a good start with the reform of childcare subsidies, but this has been blocked in the Senate because of the insistence on linking it with a crazy attempt to save money on paid parental leave in a way that would discourage employers from offering paid leave at their own expense.

The government should ensure that lack of available childcare isn't limiting young mothers' participation and continuing progress in their careers.

It could do much more to reduce the amazingly high effective marginal tax rates that discourage "secondary earners" (aka married mothers) from moving from part-time to full-time.

And then it could take a more careful run at winning public support for raising the age pension age to 70. We can get on with a slow phase-in, or wait until it's unavoidable.

Wednesday, July 6, 2016

Who really wins from Mediscare

The success of Labor's "Mediscare" in this election is worrying - but not for the reason you may imagine. Its greatest effect may be to fatten the incomes of medical specialists and corporate medical suppliers.

Scare campaigns are often effective politically, but they can impose a high price on the country's good government.

Tony Abbott's highly successful scare about depredations of the carbon tax at the last election has left us bereft of an effective and relatively low-cost means of reducing our greenhouse gas emissions at a time when climate change is worsening and we've been obliged by international pressure to agree to a tighter target.

Bill Shorten's claim that the Coalition is bent on privatising Medicare could leave us with politicians of all colours lacking the courage to do anything to restrain the rapid growth in federal and state spending on healthcare by insisting on greater efficiency and more realistic charges for medical services.

The people who work in the House with the Flag on Top take just a few days after an election to reach agreement on why the winners won and the losers lost.

Right or wrong, this conventional wisdom sticks in the minds of pollies on both sides for many years.

Should the politicians conclude that the wrath of voters will descend on any government caught making any change that could, by any stretch, be described as privatising Medicare, the people making excessive incomes out of healthcare will be laughing and the rest of us will be paying.

Labor's Mediscare was more subtle than Abbott's crude claims that the carbon tax would wipe out Whyalla and lift the price of a lamb roast to $100.

Its distortion and exaggeration was based on the meaning attached that emotive word "privatisation". We know from repeated polling that voters overwhelmingly disapprove of all privatisation.

The righteous indignation with which ministers condemned Labor's claim as "extraordinarily dishonest", an "absolute lie" and "some of the most systematic, well-funded lies ever peddled" rest on a narrow interpretation of the word.

Privatisation means taking a profitable government-owned business and selling it off to private interests. Since Medicare isn't a profitable business, the claim is absurd.

Labor, however, was using the word more broadly to mean any change that involves reducing the role of government and increasing the participation of private businesses.

Its pretext for making its claim was the Turnbull government's intention to save a little money by shifting the processing of Medicare's many bank transfers from its giant cheque-writing agency, the Department of Human Services, to a private provider.

We wouldn't even have noticed this back-office switch, but Malcolm Turnbull felt obliged to swear the proposal would be abandoned.

But the effectiveness of this scare - and the vehemence of the Coalition's denials - rests on its large element of truth.

Labor was relying on voters remembering Abbott's broken promise to leave Medicare untouched with his first budget's plan to impose a $7 co-payment on pathology tests and GP visits.

The outcry forced him to abandon that plan. In subsequent budgets, however, the government has sought to achieve savings by ending the extra bulk-billing incentives paid to providers of pathology tests and by continuing from 2014 until 2020 the freeze on increases on the schedule fees doctors receive under bulk-billing.

Here the doctors' union has been doing Labor's work by scaring their patients with claims this would force them to abandon bulk-billing and charge big co-payments.

This is untrue in the case of path tests (where the schedule fee far exceeds the costs incurred by the two big public companies that bulk-process three-quarters of our tests) and greatly exaggerated in the case of the continuing freeze on schedule fees.

But what does the public take the word Medicare to mean? I think we're mainly referring to bulk-billing and the federal grants for state government public hospitals, which are conditional on hospital services being free of direct charge.

The public loves bulk-billing because it provides the illusion of something for nothing. But the Coalition has decades of hostility to bulk-billing. The $7 co-payment was an attempt to break it down immediately and the continuing freeze on schedule fees will break it down slowly.

This was the element of truth in Mediscare. What's more, the Coalition still plans to press on with most of Abbott's cuts in grants for public hospitals of $57 billion over 10 years.

The public's attachment to bulk-billing may be irrational, but health economists have two rational reasons for wanting it to survive.

First, it adds to the overall efficiency of the healthcare system by reducing the amount doctors need to spend on billing and collecting money. This is why doctors' initial opposition to bulk-billing turned to support.

Second, because its continuation is so valuable to doctors, bulk-billing gives the government of the day the ability to limit the annual increase in GPs' and pathologists' fees - provided it doesn't push the doctors too far.

Ever-rising healthcare costs are the biggest single threat to combined federal and state budgets. There is scope for the removal of inefficiencies that do more to line medical pockets than benefit patients.

In every case, doctors will resist the removal of those inefficiencies by telling their patients it's an attack on Medicare, not the doctors' wallets. That's why the success of Mediscare is a worry.

Monday, July 4, 2016

Voters reject economics as usual

Assuming the government scrapes back in, this surprisingly poor election result for the Coalition carries hard lessons for politicians and those who seek to influence the policies they pursue: business people, economists and econocrats.

In this election economic issues dominated, and those hard lessons are about economic management and economic reform: what voters will let you do and what they won't.

It was a fight between a "national plan for jobs and growth", and health and education. Guess what? Spending cuts lost more votes than tax increases did, or than tax cuts won.

The temptation to explain the Coalition's disappointing result in terms of personalities ("I've never liked Malcolm and now I have proof") and poor political tactics, shouldn't be allowed to obscure the lessons for economic policy.

There are two. First, the strategy of trying to fix the budget deficit solely on the spending side has been a dismal failure. Only a more balanced approach is likely to be politically acceptable.

The Coalition will do itself a disservice if it believes its own bulldust that it did so poorly purely because of the success of Labor's big lie about privatising Medicare. More on that another day.

The strategy of the Abbott government's first budget was to return the budget to surplus by cutting government spending while avoiding tax increases or cuts in tax concessions almost completely.

The public's reaction was so hostile Tony Abbott was rendered unre-electable. But, though few of those measures went through, Scott Morrison has persisted with the strategy by repeatedly claiming the budget has a spending problem, not a revenue problem.

Such a strategy involves fixing the budget at the expense of low and middle income-earners, while largely shielding high income-earners and business.

The political arithmetic of this was always what Sir Humphrey would call "courageous" and so it proved on Saturday.

Remember, the Turnbull government's plans still included huge cuts in grants to the states for public hospitals and schools, plus measures doctors claimed would force them to stop bulk-billing. Plus an unspecified future increase in university fees.

Many voters would also remember the enormous stuff-up of the attempt to privatise technical and further education.

On the other side of the budget, the Coalition has acted as though fixing the deficit by increasing taxes or cutting tax concessions was economic and political anathema.

This is nonsense - as the election shows. The government actually went to the election with plans to increase taxes, on tobacco and on multinational companies, which drew no criticism.

Its plan to cut superannuation tax concessions drew noisy criticism from a few people who would never have not voted Liberal.

Its heavy past – and future – reliance on bracket creep drew no criticism. Nor did Labor's plan to continue the temporary "budget repair" levy on high income-earners.

Point is, the Coalition's willingness to propose tax increases came only to help pay for its planned phase-down in the rate of company tax, not as part of its efforts to return the budget to surplus.

It lost votes for wanting to cut company tax, thus reducing any political benefit from its plan for jobs and growth. In any case, the cuts are now unlikely to get far in the Senate.

Message: we won't achieve much in fixing the budget until we're prepared to increase tax as well as cut spending and, in the process, share the burden more fairly between the top, middle and bottom.

The election result's second lesson is that, in our efforts to make "reforms" that increase economic efficiency and improve our productivity, we should stop gratifying rent-seeking by big business and start listening to other advice, including the majority of recently polled economists saying the long-run growth dividend from spending on education is greater than an equivalent amount spent on business tax cuts.

We should abandon the voter-rejected experiment with reform via tax changes and shift to productivity-enhancing reform of education, infrastructure and, would you believe, health (because health is one of our biggest and fastest growing industries, but quite inefficient).

If you think this conflicts with all I've just said about repairing the budget in ways voters will accept, it's clear we – and, more particularly, our pollies and their econocrat advisers – have a lot more thinking to do.

Lifting our productivity via education, infrastructure and health doesn't have to involve spending a lot more on them, and may well involve achieving slower rates of spending growth.

That's because it mainly involves making spending in these areas more efficient and effective. That is, genuine reform, not just the mere cost-shifting we tried – and voters have rejected.

Saturday, July 2, 2016

Infrastructure spending isn't good if it's just vote-buying

There's a great weakness in the (otherwise sound) argument that borrowing for infrastructure is a good thing, adding to demand in the short term and improving productivity and supply in the medium term. We should be doing a lot more of it, which would impose no unfair burden on our children.

That weakness has been exposed by the election campaign. Marion Terrill, of the Grattan Institute, has looked at the parties' promises to build new transport infrastructure and found that a lot of them would be a waste of money. If so, all bets are off.

The fancy arguments don't work if the projects are chosen for their ability to buy votes rather than for the value of their contribution to improving our transport.

On some measures, by the way, transport projects – including roads, rail, ports, public transport, airports and bicycle infrastructure – account for about 70 per cent of our total infrastructure effort. They leave out the national broadband network and state spending on water and power.

With the two big parties committed to returning the budget to surplus, to changing the mix of government spending in favour of capital rather than recurrent spending, and to using the expertise of Infrastructure Australia to improve the evaluation and selection of projects, you might expect – especially if you'd just arrived from Mars – to find all this influencing the promises they made at this election.

It will amaze you to learn that, come elections, the parties don't practise what they preach.

One of the biggest steps towards getting more economic benefit from our infrastructure spending was the establishment by Kevin Rudd in 2008 of the semi-independent Infrastructure Australia. The Coalition has fully supported it and various states have set up similar bodies.

As Terrill says, now we've got IA, the parties' selection of projects should be simple. It examines projects worth more than $100 million that are of national significance.

It assesses the "business case" – buzzword for a cost-benefit analysis – of such projects and sorts them into three categories.

Those that are fully assessed and pass the test are classed as a "project". Those that fail their full assessment – that are judged not worth doing – have their evaluation published on the IA website.

Those that are yet to be fully assessed are classed as an "initiative". A case in point is the Melbourne Metro Rail.

Terrill examined the Coalition's list of transport promises (worth $5.4 billion) the Greens' list ($6.5 billion) and Labor's ($6.7 billion).

The Greens have no projects that are IA-approved, and almost half the cost of their promises is for schemes that aren't even being assessed.

Only the tiniest part of Labor's spending is on IA-approved projects, with about a third going on schemes it isn't even looking at.

Of the three parties, the Coalition has the highest spending on IA-approved projects and the lowest on schemes it isn't assessing. Even so, most of its spending would go on initiatives still being assessed.

In other words, all three parties have selected their projects with little reference to the IA's evaluations. In fact, they make a mockery of the IA process and its efforts to ensure taxpayers get value for money, which they profess to support.

But why? In a word: politics. For a fuller answer, Terrill offers circumstantial evidence.

One clue is that both big parties have plenty of projects worth less than $100 million each, which thus can't be assessed by IA.

Whether it makes sense for the federal government to get involved with such small-beer projects when they can be handled by state and local government is a good question.

Another clue is that there are only six projects on the IA's list of things worth doing: the WestConnex motorway and the M4 motorway upgrade in NSW, the Ipswich motorway and the M1 Pacific motorway in Queensland, the Perth freight link in Western Australia and the Brisbane-to-Melbourne inland freight railway.

The Coalition has only four of these on its list of promises. Labor has just one. The Greens have none, having chosen to nominate one major public transport project in each capital city.

One of the six worthwhile projects – the Sydney M4 motorway upgrade – isn't supported any of the three.

Clue three is that Australia is a federation of states and territories. Clue four is that parties attain government by winning the most electorates.

Though it may be that some states don't have any projects of national economic significance while others have quite a few, it wouldn't be surprising to see projects being spread across the states in a way that roughly fits their shares of population.

Sorry, doesn't fit. Terrill divides the value of the three parties' promised projects between the states, ensuring no double-counting. Queensland gets the most and Victoria gets quite a bit more than the larger NSW. WA also gets a disproportionate share.

Actually, she says Queensland has been getting more than other states for a decade. Maybe it's the state where elections tend to be won or lost.

Whereas almost all of the projects IA approves are in capital cities – improving commuting and connections with ports and airports – the two main parties prefer to spend in the regions.

Perhaps the regions have more marginal seats (or National Party electorates needing to be squared away by the Coalition).

The Coalition is promising $185 million to duplicate the Princes Highway from Winchelsea to Colac in Victoria, which IA has found would yield benefits worth 8¢ for every $1 spent.

You don't have to be Einstein to conclude a lot of spending on capital works – federal and state – is used to buy votes, not to make worthwhile additions to our infrastructure than improve our productivity.

If so, such spending will leave a burden for our kids.

Wednesday, June 29, 2016

Parties' similarities and differences on economics

I get criticised by rusted-on supporters of both sides of politics when I say this, but that doesn't stop it being true: there are differences between the two sides' policies, but they're not as great as they want us to believe (and their supporters do believe).

So let's identify the main points of agreement and disagreement. Most argument in election campaigns is about economic issues, with much less disagreement on other issues.

On economic management the parties are agreed on the issue which, though it's rarely acknowledged by either side, is by far the most significant: that the day-to-day management of the economy be left to the Reserve Bank, acting independently of the elected government.

That just leaves the government in control of its budget, which does have effects on the economy in the short and longer term but, because it's all the pollies have left to argue over, gets more attention than it deserves.

On getting the budget back into surplus – and so getting the level of public debt falling rather than continuing to rise – there's little to choose from. The Coalition isn't in any hurry, and nor is Labor.

Malcolm Turnbull says his policies won't have the budget back to surplus until 2020-21, after which the surplus will stay tiny.

Bill Shorten's plans say he will get back to surplus in the same year, though he'd spend an extra $16.5 billion over the four years, but then add an extra $27 billion to the surplus in the following years to 2026-27.

(You can say who knows what will happen in four years' time, let alone 10. True. But remember this applies equally to both sides' figuring. All we can do is focus on the estimated effects of the measures each side promises to take.)

The main differences between Labor and the Coalition occur because Labor would not proceed with the government's planned cuts to spending on education and health while, on the other hand, it would continue the 2 per cent "deficit levy" on income above $180,000 a year but wouldn't proceed with the government's planned cut in company tax.

It's because the cost of the company tax cut grows strongly in the later years, as do the savings from Labor's plan to "grandfather" its limits on negative gearing and the capital gains tax discount, that Labor's budget plan would take so long to improve the budget balance.

It's clear from this that when the Liberals accuse Labor of being into "spending and taxing" it is guilty as charged.

The harder question is whether government spending and taxes would be all that much lower under the Coalition. If so, it won't be by as much as it would have us believe.

It's not clear, for instance, that the Coalition will have the political courage to press on with the cuts in grants to the states for public hospitals and schools that are built into its budget figures.

The main difference is likely to be in the categories of spending that grow faster or slower under each side, and in the types of taxes and tax concessions that are cut or increased.

For instance, it's clear to me that the high cost of cutting the rate of company tax will have to be covered by more bracket creep and fewer income tax cuts.

On particular tax promises, though both sides are promising cuts to superannuation tax concessions, the Coalition's plans are clearly superior, whereas Labor's plan on negative gearing is far more attractive to young would-be home buyers.

The public's conviction that the Coalition is the better manager of the economy seems to roll on regardless of evidence. In truth, it's not supported by the record. Both sides have had their achievements and their stuff-ups.

Economic threats don't come bigger than climate change. Here, both sides' plans fall short. The Coalition has announced no credible plan to achieve the commitments it made in Paris which, in any event, were inadequate.

Labor is braver, but not by much. It plans a hugely ambitious target for growth in renewable energy, but doesn't show how it will be achieved. It plans a quite innocuous emissions trading scheme.

Both sides descend to dishonest scare campaigns. Both sides have previously supported policies they now vociferously oppose. Both may oppose policies simply because the other side supports them.

In some cases their disagreement is greater than they want to admit (penalty rates, for instance), whereas in others they disagree more in words than deeds (foreign aid; the national broadband network).

One rule-of-thumb that still works is that, in their decisions about spending and taxing, the Coalition will tend to favour business and higher income-earners, whereas Labor will tend to favour "middle-class and working-class Australians". Take your pick.

Monday, June 27, 2016

Business lobbies sell out Aussie shareholders

One thing we've learnt from this election campaign: whoever's interests our business lobby groups represent, it's not Australian shareholders.

That's clear from their vociferous defence of Malcolm Turnbull's hugely costly promise to cut the company tax rate from 30 to 25 per cent, even though our system of dividend imputation means local shareholders have little to gain from the cut.

Local shareholders would have the present 30 per cent rate of their "franking credits" cut back in line with the fall in the company tax rate. Something similar would affect all Aussie workers with superannuation.

The business lobbies carry on about the company tax cut as if the loss of revenue to the budget had no opportunity cost. In truth, the gap would mean higher budget deficits (and a higher interest bill to taxpayers) unless it was covered by cuts in the provision of government benefits and services, or by higher taxes.

It would probably be some combination of the three, with most weight taken by higher income tax, brought about by further bracket creep in the absence of tax cuts.

The budget's tiny tax cut for income-earners on more than $80,000 a year was almost a tacit admission that this was the last tax cut any of us would be seeing for many a moon.

Point is, while local shareholders have little to gain from the company tax cut, they'll bear their share of its cost.

There could be no more convincing refutation of the eternal fiction that company executives represent the interests of their shareholders. Economists have recognised this conflict of interests since the work of American economists Berle and Means in 1932.

So what's motivating the business lobby groups in their enthusiasm for a company tax cut? Well, though Australian shareholders would be little better off, the company itself would be paying less tax, which its executives may regard as an improvement.

Of course, the shareholders who would benefit from a lower tax are the foreign owners of Australian shares, since they receive no imputation credits to be reduced.

Provided, however, their home country doesn't have a company tax rate higher than ours. This means American shareholders – who supply at least a quarter of our equity capital – ultimately have nothing to gain from the cut.

The Internal Revenue Service taxes US owners of foreign shares at the American company tax rate of 36 per cent, less whatever tax they've already paid to a foreign government.

So, in principle, cutting the tax we extract from them actually benefits the IRS, not our foreign shareholders.

Of course, many big American multinationals turn legal cartwheels so as to have their Australian profits taxed at a nominal rate in some tax haven. But they escape paying the US's higher tax rate on those profits only for as long as they keep them offshore (and thus unable to be passed on to their US shareholders).

It's not so surprising that the most untiring urger of the company tax rate cut, the Business Council, should be so uncaring about its lack of benefit to local shareholders.

It's a club of the chief executives of our biggest companies. Its conception of what's good for business is what's good for company executives.

What's more, many of the council's Australian chief executives would be answerable to head office executives in foreign countries. So they'd be pleased to see a tax change the primary beneficiaries of which were foreign shareholders.

Similarly, it's not surprising to see the Minerals Council so supportive of the proposed cut. It's dominated by the three foreign global mining giants that dominate our mining industry: BHP-Billiton, Rio Tinto and Xtrata-turned-Glencore.

To those guys, Oz is just a place to be exploited – in both senses of the word.

What's harder to comprehend is why the other business lobby groups – the Australian Chamber of Commerce and Industry and the Australian Industry Group – have been so enthusiastic about a cut that would bring so little benefit to local shareholders.

It's surprising because both groups purport to represent the interests of small business. Almost by definition, small business is Australian-owned.

And with a genuinely small business – where the owner-manager is also the chief shareholder – the business's profits (those not taken as salary and perks) will always ultimately be taxed in the owner's hands, meaning most of the benefit from the lower rate of company tax is lost through the equivalent cut in franking credits.

But so great was AiG boss Innes Willox's lust for a lower company tax rate that at one stage he proposed paying for it by abolishing dividend imputation. Not sure he'd thought that one through.


Saturday, June 25, 2016

Productivity and fairness should go together

They say we get the politicians we deserve but recent weeks convince me we also get the election campaigns we deserve. When we're moved more by scare campaigns than by policy debate, guess what the pollies give us?

To the extent that we have been debating policy choices, we've had economic policy but much less social policy.

That's pretty standard for elections. The Coalition's offering has been mainly about its "plan for jobs and growth".

What could be more important than that? Ignoring climate change, not much – provided we remember that the income from jobs and growth needs to be shared widely and fairly, including with people unable to work.

They haven't mentioned it much in the campaign, but our politicians and their economic advisers are worried that our prospects for economic growth are weak because our productivity – production per worker – isn't improving as much as it used to.

In its latest annual economic outlook, the Organisation for Economic Co-operation and Development – a club of mainly rich nations – very much shares that concern.

But here's the trick: unlike our economic managers, the OECD brackets weak productivity improvement with worsening inequality of incomes, describing them as "a twin challenge".

The two issues are interrelated. Although the report doesn't canvas the respects in which inequality may be contributing to weaker productivity improvement, it does emphasise that the policy measures we choose to improve productivity could come at the expense of worsening inequality, or could improve both productivity and income equality at the same time.

That's one of the big discoveries of the international economic agencies in recent years: whereas economists have long assumed that "efficiency" and "equity" (fairness) are conflicting objectives, there are various policy choices that can bring us more of both.

Part of this is their realisation that the size of a country's government – its level of taxes and government spending – has little bearing on its government efficiency and rate of growth.

The report notes that most advanced economies have experienced slower rates of productivity improvement since the early 2000s.

Income inequality – the gap between the highest and lowest incomes – has been widening for the past two or three decades.

"The productivity slowdown and the rise in inequality have impacted the wellbeing of many workers and their families. Low- and middle-income households have had to cope with slow-growing, and in some cases stagnant or falling, real incomes," the report says.

"These trends are threatening progress in living standards, fiscal sustainability and social cohesion."

(If you wonder why so many Americans have flirted with a clown like Donald Trump, I think it's their uncomprehending way of reacting against the fact that so many of them have gained so little extra real income from the United States' economic growth over the past 30 years.)

In a well-functioning economy, wages – real, not just nominal – should rise in line with the improvement in the productivity of labour.

So the report says lower rates of productivity growth have been bad news for workers, since this has reduced the room for productivity-driven growth in real labour income (wages).

But it's worse than that, for two reasons. First, average real labour income across the OECD's rich member countries has grown less than productivity has grown.

That's particularly true for the US but, according to the OECD's calculations at least, also for us.

Second, the inequality of labour income has increased, with some employees getting much bigger wage increases than others.

Over the period from 1990 to 2013, the rich members' labour productivity grew by 3.1 per cent a year until 2000, then by just 0.9 per cent a year for the past 13 years.

But whereas productivity improvement averaged 1.8 per cent a year for the full period, average real labour income improved by only 1.5 per cent a year.

And remember that, because of the presence of a relatively small number of very highly paid employees, the average (mean) income is always higher than the more-representative "median" (dead middle) income, which improved by just 1.3 per cent a year.

But it's worse even than that. Since 1990 the real disposable income of the top 10 per cent of households has increased by 30 per cent, whereas that of the bottom 10 per cent has increased by only 4 per cent.

(Note that "labour" income becomes "market" income when you add households' capital income – from profits, dividends, rent or interest earnings – and then becomes "disposable" income after you allow for taxes paid and welfare benefits received.)

So what can be done to tackle the "twin challenge" of weak productivity improvement and worsening inequality? You look for those policy changes that create "synergies" between the two.

The report says productivity growth has slowed partly because of weak demand since the global financial crisis. Governments need to stimulate demand (spending) by making more use of fiscal (budgetary) policy, it says, implicitly criticising the resort to policies of "austerity" by governments in Europe and elsewhere.

This would not only reduce inequality immediately by reducing unemployment, it would help reduce inequality more permanently because "long-term unemployment erodes the skills of workers and their earnings prospects".

In resorting to fiscal stimulus, the emphasis should be on increased public investment in infrastructure because this adds more to demand than do tax cuts or increased recurrent spending – it has a larger "multiplier" effect.

The report says government effectiveness in delivering high quality services – such as education, health and transport – is empirically associated with higher economic growth and productivity, plus lower income inequality.

"The empirical links of better and more education [particularly early childhood education] with higher growth, productivity and equality suggest long-term benefits from a greater share of education in public spending," it says.

If we were having a more adult election campaign, these are issues we'd be debating.

Wednesday, June 22, 2016

Baird's budget is the model of conservatism, not reform

If, in these strange times, you have ever wondered what a genuinely conservative government would look like, consider the Baird government as revealed by its budget.

Premier Mike Baird and his Treasurer, Gladys Berejiklian, are cautious and responsible to a fault, putting retention of the government's AAA credit rating above all other objectives.

But, almost by definition, this makes them complacent, unimaginative and lacking in initiative. They are also claiming far too much of credit for the NSW economy's strong performance in recent years, especially relative to the other states.

It's true the state economy has been performing much better. But though the Coalition government has done more to help than to hinder, most of what happens in the economy is outside its puny control.

It's swings and roundabouts. Sometimes other states are growing more strongly than we are; at others - like now - it's our turn to lead the pack. In this our tendency to recurring property booms is a great help (though not to first home buyers).

Berejiklian tells us that "since coming to office in 2011, the NSW government has created 338,600 jobs". Really? Private enterprise played no part in it, eh?

Over the past year, we're told, NSW has created more jobs than any other state and now has the nation's lowest unemployment rate.

True. But what's equally true is that NSW has the lowest proportion of its population in employment - 60.7 per cent, against a national average of 61.1 per cent.

The economy's strong, property-fuelled growth, combined with the effects of privatising various government businesses, has led to rapidly rising budget revenue.

By maintaining fairly tight controls on government spending - particularly on the wages of government employees - Berejiklian has achieve ever-growing budget surpluses.

These surpluses have allowed a big increase in spending on infrastructure without much increase in government debt, thereby preserving our top credit rating.

With so much expansion and renewal of infrastructure needed, a government so well-placed financially and politically could afford to defy the strictures of the discredited American ratings agencies, but that's not the conservative way.

A truly conservative government is largely content with the world as it is and leaves "reform" to the radicals on the other side.

That's certainly been this government's approach. This budget only now honours an eight-year-old commitment to abolish three minor taxes on business transactions.

The government has done so because it has belatedly realised it could make up most of the lost revenue by imposing extra conveyancing duty and land tax on foreign purchasers of real estate.

Is this economically efficient? Does it fit with all the Coalition's talk about the need to encourage foreign investment?

Who cares? The government knows the impost on foreigners will be popular with voters, and is (rightly) confident it will do little to discourage investment - meaning, however, it will do little to make homes more affordable to locals.

Where did this bright idea come from? Although Berejiklian claims NSW is "leading the way in innovation" it came - as did other tax reforms adopted - from those hopeless Victorians. And Queenslanders.

This budget will keep us well away from financial bother. But it could have been much better.