Time for new thinking on reforms to encourage growth

Disheartening times are times for fresh thinking. The voters' effective rejection of conventional economic solutions at the election require our economists and policy makers to go back to the drawing board.

It's always tempting to blame the salesman for his failure to make a sale but, of late, that argument is wearing thin. It's more useful to ask whether sales would be more forthcoming if we improved the product.

Everyone accepts the importance of innovation and agile thinking but, as with most professions, it doesn't come easy to economic practitioners.

They need to go back over their thinking, looking for factors they may have missed or conclusions that aren't as solid as they've long assumed.

One simplifying assumption economists have long relied on is that "equity" and "efficiency" are in conflict. The things you could do make the economy fairer come at the cost of reducing incentives and causing the economy to grow more slowly.

Conversely, the things you could do to improve incentives and growth will, regrettably, make the economy less fair.

On this, however, the tide of international opinion is turning. Several studies by economists at the International Monetary Fund and the Organisation of Economic Co-operation and Development find that increased inequality of income leads to slower economic growth.

If this advance in understanding of ways to encourage growth has filtered through to "the government's chief economic advisers" in Treasury, we've yet to see any sign of it.

But the message hasn't been lost on the Labor Party's think tank, the Chifley Research Centre. In a paper prepared for the centre, Equity Economics, a consultancy, explains the two mechanisms by which inequality can dampen economic growth.

First, the more of the growth in income that's captured by high income earners, the less income that flows back into consumption.

This is because high-income households tend to save a much higher proportion of their income than do middle and particularly low-income households.

It's clear this is a big problem in the United States, where a quite amazing proportion of income growth is being captured by the top few percent of households.

It would be a significant factor in helping to explain America's low rate of growth in recent decades.

It's not such a big factor in Australia yet, but it will be if we let our top few percent continue increasing their share at the rate they have been.

The second mechanism by which inequality dampens economic growth is longer term. Lower growth in the incomes of families towards the bottom of the distribution limits their ability improve their knowledge and skills by investing in their own education.

The same applies when governments shifting more of the cost of healthcare on to out-of-pocket payments discourage workers from doing all they should to protect their health.

The Gini coefficient measures income inequality on a worsening scale from 0 to 1. Modelling by the OECD has found that a reduction of 1 percentage point in the coefficient will cause the level real gross domestic product in 25 years' time to be up to 5.7 per cent higher than otherwise.

To err on the conservative side, Equity Economics caps the increase at 3 per cent, before comparing it with modelling exercises showing that the national competition policy reforms of the 1990s raised the level of GDP by 2.5 per cent, and that the combined preferential trade agreements with Japan, South Korea and China will raise the level of GDP by just 0.1 per cent over the long term.

Now, I never take such modelling results too seriously. They rest on too many unstated and debatable assumptions. But the comparison does suggest there's a lot to be gained by taking steps to halt the continuing widening of the gap between high and low income-earners.

So what sort of reforms could be made to improve growth in this way?

Of the paper's five suggestions, the top two are, first, improve access to quality education to increase economic and social mobility, starting with early childhood education, right through to needs-based student funding and affordable higher education.

Second, improving labour outcomes for women, through flexibility in childcare options, paid parental leave and reducing the gender pay gap so that returning to work is financially viable.

Clearly, such reforms are very different from those that economists have been pursuing – with so little acceptance by voters.

Although their cost could be covered by equity-enhancing tax reforms – affecting negative gearing, the capital gains tax discount, superannuation and the taxation of multinational companies – they require policy makers to be more agile in their thinking than they've been to date.

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Big change ahead for China and our export challenge

You don't need me to tell you we lucked out when we sited our island continent not too far from China. But will our luck hold?

Or, more pointedly, what do we have to do to ensure we stay lucky?

A major report, released this week, Partnership for Change, seeks to answer that question. It was prepared jointly by Professor Peter Drysdale, of the East Asian Bureau of Economic Research at the Australian National University, and Zhang Xiaoqiang, of the China Centre for International Economic Exchanges, with strong support from both governments.

Actually, our location on the edge of Asia is only half our good luck. The other half was discovering our island is rich in high quality, easily-won minerals and energy.

As a result, our economy has proved a fabulous fit with the re-emerging China. As the report explains, "Australia and China are deeply complementary trading partners".

Our "comparative advantage" is opposite to China's. A country has a comparative advantage in producing a particular item if it can do so at lower opportunity cost than other countries face.

"Australia has a large natural resource base relative to its population [so it] therefore specialises in the production of primary goods for export, and uses the proceeds to purchase labour-intensive and other manufactured goods," the report says.

"Conversely, China has a large labour supply, but relative to its population has smaller endowments of natural resources and accumulated capital. For this reason, China's industrial development was built on labour-intensive production, which it exchanges with Australia for imports of scarce resources."

And what a successful partnership it's been. In the space of not much more than a decade, China has become our biggest trading partner. It takes about 35 per cent of our exports of goods and services, and supplies almost 20 per cent of our imports of goods and services.

China is so big - its population is 56 times ours - and has been so successful in pursuing this growth strategy it's now the second biggest economy in the world (the biggest, if you allow for differences in purchasing power), the biggest trading nation and the world's biggest producer of manufactured goods.

But nothing stays the same. The resources boom that saw our trade with China grow so dramatically has reached its final stage. Prices for coal and iron ore have now fallen back.

The period of massive investment in new mines and natural gas facilities is ending, with construction spending falling sharply. The last stage is big growth in the quantity of our mining exports, with large increases in natural gas exports (mainly to China) still to come.

The boom was ended by big increases in the supply of commodities (from our competitors as well as us), but also by a slowing in China's demand as its need for more steel peaked.

So, after a period of huge expansion in our mining sector, our economy is making the adjustment back to normal, where most growth in production and employment comes from the ever-expanding services sector.

This is happening, with a few bumps. But, as part of its progress to full economic development, China is going through a much more dramatic "transition".

The report says China is "shifting its growth drivers from investment, exports and heavy industry to consumption, innovation and services".

"Chinese production is shifting from a model based on adaptation and imitation of goods, services and technologies developed elsewhere, to a model based on domestic innovation", it continues.

Part of this involves a shift from labour-intensive, low-tech, low-value manufacturing to more advanced, high-tech, high-value manufacturing.

This has already started.  Over the 20 years to 2015, low-tech manufacturing's share of China's total exports of goods has shrunk from almost half to less than 30 per cent.

So the big question is whether, now China is changing direction, it will still be the gold mine it's been for us so far.

China will still need to import a lot of our natural resources, even if its demand for those resources won't be growing as fast.

The report notes that, with prices so far down, our share of China's import market has increased markedly. Huh? It's because, compared with our competitors (including local Chinese mines), we're such an efficient, low-cost producer.

The report has modelled three scenarios for our trade with China over the next 10 years. Drysdale stresses the results aren't exact, but give us an idea.

The "baseline" scenario, where existing trends continue without much change, would see our exports to China grow by 72 per cent, while China's exports to us grew by 41 per cent. (All these figures are in real terms.)

The pessimistic scenario sees China's annual growth falling below 5 per cent during the decade. Even so, our exports to China would grow by 28 per cent, while their exports to us grew by 20 per cent.

The optimistic scenario, however, would see our exports to China grow by 120 per cent, while their exports to us grew by 44 per cent.

And the catch? Both countries would need to engage in supply-side (production) reforms to make it happen.

For China, this would involve reforming its banks and financial system, reforming its state-owned enterprises, and liberalising the capital account of its balance of payments by lifting restrictions on money flows and allowing a freer-floating exchange rate.

For us, it would involve increasing competition in sheltered industries, openness to foreign investment and skills, and facilitating investment in social and physical infrastructure.

These are what we'd have to do to make real our dream of getting our share of all the extra demand for fancy food and services coming from China's by-then massive middle class.

Here we'd be battling against a different and much bigger range of competitors than we face in the commodities market. You wonder if our spoilt business people are up to it.

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You have no idea how hard it is for big business

I have disturbing news. The big business people of Australia are feeling quite upset about the recent federal election, or so I am informed by The Australian Financial Review.

Quite frankly – and this is a shocking thing to say – the mood of the campaign was "anti-business". As young people say, big business was disrespected.

Those rotters in the Labor Party were shameless in their behaviour, seeking to win votes by portraying their Liberal opponents as apologists for big business.

Why did the Libs have cutting the rate of company tax as pretty much the only item in their plan for Jobs and Growth? Purely, so the voters were asked to believe, to please the Libs' cronies at "the big end of town".

Why were the Libs so vigorous in their opposition to Labor's idea of a royal commission? Because they were doing the bidding of their big four banking mates, Labor claimed.

Really, it was disgraceful. But perhaps even more depressing was the performance of the Libs.

Malcolm Turnbull, one of our own – and didn't those Labor people keep hinting at it – the man in whom we had such faith after Tony Abbott's failure as their longed-for messiah, has proved such a disappointment.

He may have championed a proposal to cut the company tax rate by a niggardly 5 per cent, but he wanted to string it out over a decade – a decade! With, mind you, big business not getting a penny until close to the end.

Talk about trickling down the trickle down. Surely if lower company tax is the big reform it needs to deliver jobs and growth, the sooner you do it the better. Be decisive. Take risks for the good of the nation.

But Turnbull lacked the leadership to increase the goods and services tax or to cut the top personal tax rate. Such a disappointment.

And he performed so poorly against Labor and the mushrooming populists – when could you ever accuse big business of trying to be popular? – he looks unlikely to be able to deliver on the company tax cut. Such a disappointment.

Then, to top it off, no sooner is the election over than Liberal loudmouths like Michael Kroger start blaming the Business Council of Australia for their poor performance.

The Libs went out to bat for big business, but we failed to back them with donations or ads. There's talk Turnbull had to pay for a lot of the campaign himself.

Well, really. It's not the business council's job to pass round the hat. The Liberals' job is to fight for the interests of big business purely in the national interest.

What part of "all care but no responsibility" do the Libs not understand?

And then there's the way the pollies suck-up to small business. All that bull about small business being "the engine room of the economy".

Yeah, sure. Say it enough times and the punters forget most of them work for big business, not small.

It couldn't be because small business has more votes than we do, could it? We could try telling our employees who to vote for, but I'm not sure we'd get far.

So politicians on both sides are a huge letdown. Why won't they show a bit of leadership? Why won't they put their jobs on the line in the national interest? Don't they think we would?

As for the voters themselves, big business is more in sorrow than in anger. How can you blame people for acting like sheep when they're so badly led?

There are so many crazy ideas abroad that the pollies have failed to scotch. Do you know there are people who think business should be paying more tax, not less?

There are people who can't see why business needs a tax cut when it's already doing such a good job of avoiding paying much. This is so unfair. Some of us do pay quite a lot of what we're supposed to.

The pollies' failure of leadership makes it hard to blame ordinary people for not understanding there's a budget repair job to do and we have to get on with it. There are "harsh realities" that must be faced.

Strong policy action must be taken and the public must be persuaded to take its medicine.

If the budget is to be balanced we all have to give up something. Businesses have already offered to give up some of the tax they pay, and now it's your turn to volunteer.

Government spending is growing unsustainably. Surely you could give up some of those free visits to the doctor. Surely you could pay more for your pharmaceuticals. Surely your pension doesn't need to be so generously indexed.

Someone needs to tell you this: all the talk of a royal commission is reducing confidence in the banking system. Stop it, or on your own head be it.

And lack of support for big business on both sides is sapping confidence in the economy.

I mean, really. With such hopeless politicians and foolish, self-seeking voters, how can big business to get on with its job?

The incompetence and unworthiness around us is so disheartening. It's all we can do to get out of bed each day and collect our pay.

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Why Treasury is wrong on deficits and debt

The last speech of the retiring Reserve Bank governor, Glenn the Baptist, was a touch biblical. Whatever your point of view, you could find a verse here or there that seemed to back you up.

If, for instance, you accept the conventional view that the budget deficit is way too high, that the government should be more daring in seeking to cut the deficit, and its opponents should be less opportunist and more responsible in agreeing to spending cuts, Glenn Stevens offered a verse for you to quote.

He observed that "when specific ideas are proposed that will actually make a difference [to the budget deficit] the conversation quickly shifts to rather narrow notions of 'fairness', people look to their own positions, the interest groups all come out and the specific proposals often run into the sand.

"If we think this rather other-worldly discussion will not have to give way to a more hard-nosed conversation, we are kidding ourselves.

"That will occur should there be a moment of crisis, but it would be better if it occurred before then," he said.

A treasury secretary couldn't have said it better. But look at the totality of Stevens' remarks and he's actually challenging the conventional wisdom.

"As would be clear from my utterances over the past couple of years, I have serious reservations about the extent of reliance on monetary policy around the world."

The problem is that what central banks do could never be enough to fully restore demand after a period of recession associated with a very substantial debt build-up.

"In the end, the most powerful domestic expansionary impetus that comes from low interest rates surely comes when someone has both the balance sheet capacity and the willingness to take on more debt and spend," he said.

"The problem now is that there is a limit to how much we can expect to achieve by relying on already indebted entities taking on more debt.

"In some countries there may be no safe way of [increasing] borrowing and spending because debt, both public and private, is just too high.

"In Australia, gross public debt, for all levels of government, adds up to about 40 per cent of gross domestic product. We are rightly concerned about the future trajectory of this ratio.

"But gross household debt is three time larger – about 125 per cent of GDP. That is not unmanageable – but nor is it a low number."

Get it? He's saying that monetary policy is out of puff. Lowering interest rates is no longer very effective in encouraging households to take on even more debt. (He noted later that he'd never believed cutting rates had much effect on businesses' decisions to increase investment spending.)

So which sector has the most capacity to increase its deficit spending "in the event that we were to need a big demand stimulus"?

The public sector. Sorry, but that's not what a treasury secretary would say.

Stevens was quick to add: "I am not advocating an increase in deficit financing of day-to-day government spending. The case for governments being prepared to borrow for the right investment assets – long-lived assets that yield an economic return – does not extend to borrowing to pay pensions, welfare and routine government expenses, other than under the most exceptional circumstances.

"It remains the case that, over time, the gap in the recurrent [my emphasis] budget has to be closed, because rising public debt that is not held against assets [my emphasis] will start to be a material problem."

Now that's something no secretary to the treasury would say. Unlike all its state counterparts, federal Treasury has long opposed the drawing of a distinction between government recurrent spending and government investment in "long-lived assets that yield an economic return" and add to national productivity.

Treasury wants little old ladies to feel as guilty about borrowing to improve the Pacific Highway as they do about borrowing for "routine government expenses".

So, let's worry about getting the recurrent budget back to surplus (as most state governments did long ago), but not about borrowing for infrastructure. Agreed?

Except that when you read the budget papers carefully enough to find the info Treasury has hidden on page 6-17, you discover that the expected underlying cash deficit for this financial year of $37 billion includes capital spending of $36 billion.

Get it? We're already back to a balanced recurrent budget. So why so much hand-wringing? And why aren't we getting on with planning the infrastructure pipeline we could expedite "in the event that we were to need a big demand stimulus"?

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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.

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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.

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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.

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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.

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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.

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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.

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