REFLECTIONS ON THE TEACHING OF ECONOMICS

Talk to Australasian Teaching Economics Conference, Sydney, Friday, July 7, 2017

When Justin Wolfers, the great white hope of Australian academic economists, spoke to the Australian Business Economists in February, he paid a special tribute to two of his economics teachers, whom he named, thanking them for instilling in him a “love of economics”. They were his school teachers at James Ruse High, not his lecturers at the University of Sydney.

There are two lessons from this. First, despite the contempt in which it is held by many economics lecturers, high school economics has long been the main recruiting ground for university economics. Some years ago in NSW, and much earlier in Victoria, the number of students studying economics at high school fell sharply, following the introduction of a more useful-sounding – and less intellectually demanding – course, business studies. If those of you from NSW are wondering why you’ve many fewer students wanting to study economics than in the good old days, I’m convinced that’s a big part of the explanation. That, plus the growing recognition that university economics is a subject which is generally badly taught, in which you do a lot of maths without seeing what it proves or how it might be useful to you in the working world.

Which brings me to the second lesson: Whether you teach at school or uni, perhaps the single most important test of your success is whether you instil in your students a “love of economics”. Whether you convince them it’s interesting, important and useful. In my experience, it turns on whether you can visually and aurally demonstrate your enthusiasm for the subject and somehow convey this enthusiasm to your students. If you can infect them with your enthusiasm – your love – for the subject, you’ve done them a huge service.

What are my qualifications for offering reflections on the teaching of economics? Well, although I make no claim to being an economist – my qualifications are in accounting, and I prefer to describe myself as a journalist who writes about economics – I did have three years of economics in the commerce degree I gained from the University of Newcastle in the second half of the 1960s, so I am qualified as a student of economics. And whether or not I’m qualified, I have 40 years of experience as a teacher of economics – partly in lectures to high school and, occasionally, uni students of economics, but mainly in my newspaper columns, which have always put a heavy emphasis on teaching. I was a part-time tutor in accounting at UNSW for two years, which helped me realise how satisfying it felt being a teacher. I’ve also had some experience over the years as a hirer and trainer of the product of your labours: economics graduates. My job gives me plenty of contact with economists – particularly with top econocrats, almost all of whom are sufficiently well-qualified to be academics, but also with academics themselves – and also with high school economics teachers, who also aren’t economists, but teachers whose topic is economics.

Throughout the five years of part-time and full-time study it took me to get my pass degree, I suffered under an appalling misconception: that accounting was really interesting, while economics was boring and pointless. I had my heart set on becoming a chartered accountant, did economics only because I had too, and it wasn’t until after qualifying as a chartered accountant, becoming disillusioned, and then washing up at Fairfax in 1974, where it was suggested I become an economic journalist (because “economics and accounting are pretty much the same thing, aren’t they?”), that I realised I’d got that exactly the wrong way round: accounting was boring and relatively unimportant, whereas economics was infinitely interesting and involved grappling with problems such as inflation and unemployment, which were of considerable importance.

I blame my lecturers – who included Brian Johns for micro and Warren Hogan for macro – for allowing me to retain the delusion that economics was boring and irrelevant to the real world of business. To my recollection, they made no attempt to put the theory they were teaching me in a wider context – to help me join the dots. I can remember wondering what a model was, and thinking that none of the businesses I audited in Hunter Street ever mentioned using a demand curve to determine their prices. It never occurred to me to wonder that one of the businesses I audited was actually a (in those days, still legal) cartel, setting the prices for the pipes and tiles made by half a dozen pottery works in the Hunter Valley.

No one paused from their exposition of diagrams and models to explain why economics relied on theories embodied in geometric or mathematical models in its attempt to explain how the economy works, why models were, of necessity, a simplified representation of reality, why a model as complicated as the real world would explain nothing, that the game was about identifying key causal relationships and not worrying about less important complications, why the test of a model was whether its choice of which factors to include and which to ignore was well judged.

It was many years before I realised that, in my late teens and even though I’d worked full-time for a couple of years in the commercial world, I was far too inexperienced in the “real world” to make sensible judgments about whether what I was being taught would or wouldn’t be of use to me in the rest of my working life. That if my lecturers thought it worth teaching me this stuff, I should give them the benefit of the doubt. It was even more years before I realised that theories about how the world works were the main thing universities had to offer and pretty much the only thing they should bother offering. Every profession has a body of knowledge that attempts to find order among the chaos in the aspect of the real world that it professes to know about, and university is pretty much the only opportunity practitioners get to learn about that theory in any systematic way. So, provided they’re teaching good theory, universities should never apologise for being theoretical. There’s not much theory in accounting, but what there is is what I’ve found most useful from what I was taught.  As a commerce graduate, no one taught me how to do a bank rec, but that’s the sort of practicality you can pick up in the first few weeks on the job.

Apart from not bothering to explain the role and rationale of seemingly unrealistic theories, I can’t remember my lecturers or tutors making much effort to demonstrate how those theoretical insights could be used to shed light on real world problems. My mate Jeff Borland at Melbourne has published a great little book of first year case studies – one I give to each of my new recruits to economic reporting – and it’s not hard to find books of case studies based on newspaper reports, if you’re not capable of finding your own. Lecturers who preside over courses that fail to link theory back to real world issues deserve to be shot. They just can’t be bothered making the effort to move from theory for its own sake to theory because it can actually be quite useful – and thus interesting.

One of the keys to being a successful explainer of economics in the media is to take the trouble to work out where your audience is coming from: what they know, what they don’t know, what their misperceptions are, which aspects interest them and which don’t. Successful lecturers do the same. I imagine students taking first-year courses fall into three main categories: those who’ll do economics for just a year or two, then take away whatever and what little they’ve learn to last them for a lifetime as a teacher, accountant, businessperson or lawyer – and a voting citizen. I imagine these would be most numerous. Next in size would be those who complete a full major in economics and go on to be economic practitioners, working in the public sector, the banks and financial markets, or eventually as self-employed economic “consultants”, or even the odd journo. Last comes the smallest group, those who’ll go on to be your successors as academic economists.

I think the great temptation you face as academics is to aim your lectures to those three groups in inverse proportion to their numerical significance. My guess is that, consciously or unconsciously, most courses – particularly those beyond first year – are aimed at educating potential academics. Why? Because not bothering to change gear is more intellectually satisfying for the lecturer and requires less effort. Where first year economics is a terminating course – say for those who’ve been conscripted by the Business faculty - the main thing students need to take away is a deep understanding of some version of Mankiw’s Ten Principles of Economics. If you’re not doing that you’re short-changing a lot of your customers.

But the student group I worry most about are the future economic practitioners. I suspect that most academics are so inward-looking and arrogant that they take little pride in what is their main practical task and contribution to economic welfare: training practitioners, many of whom will have much greater influence over the management of the macro economy and the efficiency of particularly industries than their teachers ever will. When I write columns criticising “economists” for some failing, I often get angry feedback from academic economists, indignantly rejecting my criticism. To many academics, economist equals academic economist. It never crosses their tiny minds that my criticism is directed at a far more socially significant group: their former students, economic practitioners. Sorry, their performance worries me far more than yours, even though the adequacy of your teaching must bear its share of responsibility for the adequacy of their performance.

I have two related worries about the adequacy of your teaching of future practitioners. First is the way I believe that, too often, your academic enthusiasm for exploring limiting cases and other intellectual fascinations crowds out the far more important task of giving students as much practice as possible in applying models to the solution of practical problems. This, after all, is just what economic practitioners will spend their working lives doing.

My second worry about the adequacy of your teaching of practitioners is my belief that you spend far too little explaining the limitations of the models you teach. All theories and models have limitations, and introducing models while failing to identify their key limitations is professional negligence. You don’t truly understand a model unless you understand its limitations. If you don’t understand its limitations, you’ve learnt from a comic, not a textbook. What are the assumptions on which the model is built? Which are the most significant assumptions? Which are the explicit assumptions and which the implicit? I had studied and written about mainstream economics for many years before Geoff Harcourt told me something I hadn’t realised: it’s based on an implicit assumption that the parties to economic transactions are of roughly equal bargaining power. That’s a hugely important assumption.

Practitioners who use models without fully understanding their limitations – and who draw policy conclusions which they publicise without warning politicians and public of the key assumptions on which they rest – are a menace to the nation, contributing to the disrepute in which economists are often held. Stuart Birks, a senior lecturer at Massey University, has written a little book called 40 Critical Pointers for Students of Economics, available via the World Economics Association, against which all of you could usefully assess the adequacy of your efforts to ensure your students understand the limitations of the models you teach them. https://www.worldeconomicsassociation.org/library/40-critical-pointers-for-students-of-economics/

Even worse, I worry that economics teachers don’t do nearly as much as they should to ensure their students understand that models are just models. I believe too many of your students walk away under the impression that some version of the neoclassical model actually is the economy. If so, you’re guilty of a terrible intellectual crime. Just this year someone who’s not an economist repeated to me the statistician George Box’s aphorism that “all models are wrong, but some are useful”. Is this what you tell your students? If not, why not? In Dani Rodrik’s recent book offering a critique and defence of conventional economics, Economics Rules, the main point he hammers is that “it’s a model, not the model. Economics is a collection of models; cherish their diversity.” I think it was Joan Robinson who advocated the “tool box” approach to economics: you assess a problem and its context, then reach into your tool box and select the particular model best suited to solving that problem. Is this what you teach your students?

I had intended to switch my critique from how you teach to what you teach, which I planned to kick off by saying that economics is half useful insights and half con job. But I’ve run out of time and if you want me to justify that assertion you’ll have to invite me back.

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Labor’s professed preference for policy purity is phoney

For the growing number of us who care more about good policy and effective governance than party loyalties, the news isn't good. With one main exception, Labor is allowing the supposed perfect to be the enemy of the good.

The exception is a good one: although the "clean [or low] emissions target" for the national electricity market recommended by the Finkel report is far from perfect as the chief means by which the Turnbull government seeks to reduce our carbon emissions in line with our Paris commitment, Bill Shorten has indicated that the opposition would be open to supporting a "well-constructed LET" in the Senate.

There aren't many issues more important than filling the policy vacuum left by Tony Abbott's abolition of the carbon tax three years ago. And, in the process, greatly assisting efforts to fix the ailing electricity market, reducing the risk of blackouts and further price rises.

Everyone bar the Coalition's crazy backbench climate-change deniers knows coal's days are numbered, which is why both sides of the electricity industry – fossil fuels and renewables – are desperate for greater certainty about how the government plans to manage the transition.

But it's not just that the government needs to make up its mind. It's also that the alternative government isn't planning to change the Coalition's arrangements.

This explains why pretty much all the adults involved have agreed that a CET or LET is the best way forward, given the aforementioned crazies' rejection of anything more sensible.

And why Labor deserves a tick for seeking bipartisanship by moving from its own, better policy for an "emissions intensity scheme" and accepting a LET, provided it isn't too badly compromised.

Now it's up to Malcolm Turnbull to get his troops' agreement to a "well-constructed" LET – which won't be easy.

Sorry, but it occurs to me to wonder whether, should Turnbull fail, Labor isn't positioning itself to claim the moral high ground on both climate change and a workable electricity market.

I wonder about Labor's motives because, on most other policy issues, Shorten is putting his electoral ambitions well ahead of the nation's interest in good policy and effective governance.

All in the name of more nearly perfect policy, naturally.

It's hard to avoid the suspicion that, though he wants to be seen as positive and co-operative, his true motive is to pay the Coalition back for the way Abbott tried to destabilise and neuter the Gillard government and to keep alive the policy differences – on health, education and budget fairness – that brought him so close to unseating Turnbull at last year's election.

Take Shorten's utterly unreasonable position on needs-based funding of schools, that because Labor's version is supposedly superior to the Coalition's, Labor should do all in its power to block the government's legislation in the Senate and leave needs-based funding in limbo until Labor's re-election.

Shorten professes to care deeply about disadvantage students, but it makes you wonder.

As Dr Peter Goss, of the Grattan Institute, has argued, "Gonski 2.0 is a precious opportunity to lock in fairer deals on school funding. It should be seized by all sides of politics.

"Australia's long and toxic funding wars must end so we can move onto other much-needed education reforms."

In any case, Goss's analysis suggests that most of the extra $22 billion over 10 years that Labor says should be spent wouldn't be directed to student need.

Next is Labor's opposition to covering the rising cost of the National Disability Insurance Scheme with a 0.5 percentage point increase in the Medicare levy, in two years' time.

Since such an increase would be roughly proportional – hitting high and low income-earners by a flat percentage increase – Shorten wants to impose the increase just on those earning more than $87,000 a year.

For good measure, he wants to continue the Coalition's temporary 2-percentage-point budget repair levy on income above $180,000 a year, beyond its promised expiry at the end of this month.

All very virtuous (and I wouldn't object to paying either impost). But not if it's used as an excuse to block the government's increase in the Medicare levy.

It's easy for those out of power to advocate making the tax scale more progressive, but this would be a first for Labor in office.

Should Shorten win the next election, I wouldn't hold my breath waiting for him to reimpose the 2 per cent levy. And he doesn't want us to remember that funding the disability scheme with a 0.5 percentage point Medicare levy increase was perfectly fair enough for the Gillard government.

Somehow, I don't think these guys are fair dinkum.

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We've slowed a lot, but we're not about to go backwards

There's no denying the economy has slowed down, by far more than we were expecting. But don't conclude it's likely to subside into recession any time soon.

This week's national accounts for the March quarter, from the Australian Bureau of Statistics, show real gross domestic product grew by a pathetic 0.3 per cent during the quarter, and by just 1.7 per cent over the year to March. This compares with its "potential" annual growth rate of 2.75 per cent.

This time last year, the government's budget forecast was for growth averaging 2.5 per cent in the financial year just ending, accelerating to 3 per cent in the coming year.

So what's gone wrong? And why is it unlikely get a lot worse?

First point: don't think the economy's running down like a battery-powered toy. Looking back over the past four quarters, we see OK growth of 0.7 per cent in the June quarter of last year, then a contraction of 0.4 per cent, then super-strong growth of 1.1 per cent and now weak growth of 0.3 per cent.

This unnatural, saw-tooth pattern says some transactions may have been recognised in the wrong quarter. For instance, investment spending by federal and state public corporations leapt by 37.8 per cent in the December quarter, but then contracted by 20.9 per cent in the March quarter.

Neither figure should be taken literally.

Two major drivers of activity at present are home building and exports of coal and iron ore. Both have been disrupted by unusual weather that's not been smoothed away by normal seasonal adjustment. Climate change?

Home building has been growing strongly for several years, but it contracted by 1.2 per cent in September quarter and by 4.4 per cent in the March quarter. Most of this is explained by unusually wet weather in some parts of the country.

The volume (quantity) of exports was up 2 per cent in the June quarter, then slowed to growth of 1.4 per cent, then leapt by 3.7 per cent and now has actually fallen by 1.6 per cent.

Much of this volatility is explained by extreme weather disrupting shipping carrying coal from Queensland or iron ore from Western Australia.

We could expect the figures for the present quarter to be boosted by a catch-up from the weak March quarter – were it not for the further disruption in April and May we know has been caused by Cyclone Debbie.

Note that a sudden build-up in business inventories contributed 0.4 percentage points to growth in the March quarter. Much of this was a jump in mining industry stockpiles, suggesting a lot of coal was produced, but couldn't be shipped.

But to explain much of the quarter-to-quarter volatility in GDP growth in terms of misallocation and wild weather doesn't alter the fact that, when you add up the four quarters, you get only to utterly weak annual growth of 1.7 per cent.

One major component of growth that's unlikely to be affected by either factor is consumer spending. It's been unusually weak in all quarters bar December, growing by a pathetic 1.3 per cent over the year to March.

And this despite households cutting back their rate of saving from 6.9 per cent of household income to 4.7 per cent over the year.

This weakness in consumption ain't hard to explain: growth in household income has been held back by weak growth in employment and, more particularly, negligible growth in real wages, notwithstanding a 1.2 per cent improvement in the productivity of labour over the year.

Real labour costs per unit – a measure of the race between real wages and labour productivity – fell 1.7 per cent in the quarter and 6.3 per cent over the year to March.

Wanna know why the economy's growth is so weak? You won't find a more powerful explanation than that.

Remember, however, that the weakness isn't spread equally across the country.

State final demand is a poor substitute for gross state product, but the best we get each quarter. Across the whole economy, domestic final demand also grew by 1.7 per cent over the year to March.

But state final demand grew by 4.5 per cent in Victoria, 3.3 per cent in South Australia and Tassie, an above-par 1.9 per cent in NSW, and a below-par 1.6 per cent in Queensland.

Now get this: in Western Australia, final demand contracted by 6.6 per cent. So the West is still bearing the brunt of the bust in the mining construction boom. This explains a fair bit of the weakness in the national average.

The West's contraction in the March quarter was just 0.2 per cent, however, suggesting the inevitable end to its contraction phase isn't far off. That's the first reason things won't continue weakening nationwide.

As part of that, the long-running fall in mining investment spending must also be within a few quarters of ending. You need to be good at arithmetic to see that, when our focus is on rates of growth, "the removal of a negative is a positive".

The housing construction boom has a few more quarters to run, and strong grow in infrastructure spending is in the pipeline.

But much depends on what happens to real wages. Certainly, the government's forecast of economic growth returning to our potential growth rate of 2.75 per cent in 2017-18 as a whole, rests heavily on a resumption of real growth in wages.

To the extent the present weakness in wage growth is merely cyclical, wages will recover soon enough. This is hardly the wildly optimistic expectation that some, who've forgotten the economy moves in cycles, have claimed.

But to the presently unknown extent that the weakness in wage growth has deeper, structural causes, we won't get back to a decent rate of growth until the government acts to fix the problem.

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Turnbull must act on climate if he's not to be a Trumpette

We are trying – admittedly, without much success so far – to make our home a Tr*mp-free zone. It's just too depressing. Watching a great nation disgrace itself before the rest of the world.

The former proudly self-proclaimed leader of the free world suffering a loss of confidence and applying for early retirement.

A nation that every year scoops the pool of Nobel prizes, electing a crazy, ignorant, wilful old man, not so much Trump as Chump.

His latest stroke of genius – reneging on America's commitment to the Paris climate agreement – has been almost universally condemned, including by a great number of Americans, especially many business leaders.

But, congenital optimist that I am, I see some perverse comfort in all this. The American people are being brought face-to-face with what it means for their future when the world's second biggest emitter of greenhouse gases decides that the minor disruption of doing something to protect itself from the huge disruption of continuing global warming just isn't worth it.

This rational self-interest?

I'm prepared to bet that the next elected president will have climate protection at the top of his to-do list. Indeed, Donald Trump's becoming such an embarrassment to his compatriots I'd bet the next president's platform will be to do the opposite to Trump on 'most everything.

Then there's the band of American state governments – led by the two most powerful, California and New York – willing to step into the leadership vacuum their federal government has left. And the mayors of many cities.

Of course, as we know from earlier this year – when our federal government sought to use South Australia's blackouts for political point-scoring rather than a cue for policy correction, thus obliging the SA Premier to step in with expensive local interventions to a national problem – having states try to make up for a federal government's refusal to accept responsibility is far from ideal.

Which bring us to Malcolm Turnbull, whose statements and actions as Prime Minister contrast markedly with what every voter knows are his long-held views on climate change.

One thing to be said for Trump is that at least he's made an honest man of himself. He has no concern about global warming and isn't willing to do anything to combat it, but doesn't pretend otherwise.

Here, Turnbull professes eternal loyalty to the Paris Agreement and reaffirms our (inadequate) target to achieve a 26 to 28 per cent reduction in emissions by 2030 from 2005 levels, without having any credible policy by which to achieve it.

Actually, we haven't had a credible policy to reduce emissions since Tony Abbott abolished Julia Gillard's carbon tax-cum-emissions trading scheme in July 2014.

Abbott's professed reason for doing so was the claimed huge increase in the price of electricity and gas the scheme caused, and the massive economic damage this would lead to.

Prices did come down a bit, but soon continued on their upward way. Truth is, the carbon tax – and the renewable energy target – were never a major part of the reason for the big increases in energy prices since the turn of the century.

Even so, concerns about climate change are at the heart of the problems we're having maintaining an energy system that avoids blackouts without costing the earth (in the earlier sense of that phrase).

That, plus the various problems that have emerged with that finest flower of micro-economic reform, the national electricity market (the greatest source of price increases).

Ancient coal-fired power stations are being closed down, while no business in its right mind would invest in new coal-fired stations that are unlikely to be used for much of their 30 to 50-year potential working lives.

At the same time, however, businesses are reluctant to invest in industrial-scale renewable energy when the Coalition government has displayed such hostility to renewables and created such uncertainty about their future.

Have you noticed how our response to climate change and our problems with electricity have morphed into the same issue?

There's little concern to limit emissions except from the generation of electricity. And there's no solution to reliable, reasonably priced power that doesn't involve controlling emissions.

On Friday the chief scientist, Professor Alan Finkel, will deliver his long-awaited report on "the future energy security of the national electricity market".

What's needed is a mechanism to regulate the transition from fossil fuels to renewables in a way that reduces emissions while providing certainty to both kinds of energy providers.

Last year all the key players agreed the best approach would be an "emissions intensity scheme". All bar the Turnbull government, which ruled it out the moment its climate-change denying backbenchers objected.

So now, we're told, Finkel has come up with a compromise, a "low emissions target", or LET, which sets the proportion of electricity production that must come from low-emission sources.

It's similar to the present RET – renewable energy target – except the list of low-emission sources would be expanded to include gas-fired power and "clean" coal-fired power with carbon capture and storage (should such a thing ever exist).

This compromise has been widely canvassed, and has a lot of support in business. Even the Labor opposition has indicated its willingness to accept some form of mechanism rather than continuing inaction.

The heat will now be on Turnbull to get his Trumpettes across the line.

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Radical policy change may be needed to fix wages

It's too early to be sure, but not too early to suspect that, if we and the other developed economies keep travelling the way we are, conventional wisdom about what constitutes good economic policy may soon need to be turned on its head.

We're living through very strange times. Each developed economy has its own story, but there are strong similarities. One is exceptionally low inflation, which doesn't seem temporary.

Another is surprisingly weak rates of measured productivity improvement, although our rate of improvement in the productivity of labour isn't too bad.

My guess is a fair bit of this is mis-measurement arising from our quite radical shift to a digital economy.

But the other explanation may be a decline in price competition in many industries, thanks to several decades of both natural and government-facilitated rent-seeking by big businesses, in ever-more concentrated industries.

Next, wages. It's too soon to conclude that wage growth – which in Oz has been slowing since mid-2012 and been pathetically weak for three years – is down for the count.

We don't yet know how much of the weakness is merely cyclical and how much is due to deeper, longer-lasting, structural causes.

Even so, it's hard not to suspect that a fair bit of the wage weakness is structural. My guess is that while we've been busy decentralising wage-fixing and removing all provisions thought to favour unions, globalisation and technological change have conspired to rob the nation's employees of any collective bargaining power.

This may sound like a dream come true for business and its high-paid executives but, if it's true, it's deeply destabilising overkill.

Wages are a key variable in the economy. Allow them to be either too high or too low and the economy gets out of kilter.

Allow the profits share of national income to keep continually expanding at the expense of the wages share and expect to pay a price economically, socially and politically.

And that's before you remember that wages are the chief source of governments' tax revenue. Not only personal income tax, but all the indirect taxes – notably, the goods and services tax – that households pay when they spend their labour incomes.

Low nominal wage growth isn't necessarily a worry if, at the same time, the rise in consumer prices is low.

What matters to working households and the rest of the economy (but not governments) is what's happening to real wages.

In a healthily functioning economy, real wages should rise pretty much in line with the improvement in the productivity of labour.

That way, both labour and capital get their fair share of the fruits of economic progress.

Trouble is, in the US this relationship broke down maybe 30 years ago, explaining why the top few per cent of households have captured most of the growth in the nation's real income over that time.

This doesn't just widen the gap between rich and poor. By directing so much income growth away from the high spenders at the bottom and middle to the high savers at the top, it slows growth in consumption and thus production.

It also adds to the disillusionment of ordinary voters, making them more likely to lash out and vote for the cunning wacko celebrity-de-jour candidate, such as Clive Palmer, Pauline Hanson or Donald somebody​.

Get this: there are tentative signs the relationship between real wage growth and labour productivity may be breaking down in Oz.

The relevant indicator, the index of real labour costs per unit, should hover around 100. It fell by 3.3 per cent during 2016, reaching 98.1, equal lowest since the series began in 1985.

If this weakness persists, it will raise the question of whether the formerly healthy relationship was a product of market forces, or the industrial relations system's achievement of a fine balance between employer and union bargaining power.

If it does persist, how could we return to a healthy relationship? By reversing the dominant wisdom of many decades, that governments must never do anything that adds to the regulatory burden on employers. By acting (very carefully) to strengthen the hand of union collective bargainers.

Final point: governments of all colours secretly rely on bracket creep to help tax collections keep up with the inexorable growth in government spending.

But bracket creep depends on both reasonable inflation and real wage growth to work its barely noticed fiscal magic.

What happens if inflation stays low and real wages stop growing? You have to junk your rhetoric about smaller government and keep doing what Malcolm Turnbull did in this budget: justify explicit tax increases.

Either that, or get wages growing properly.

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How and Why we've escaped recession for so long

When Glenn Stevens took over from Ian Macfarlane as governor of the Reserve Bank in September 2006, both men knew the new boy was being handed a poison chalice.

By the time of the deep recession of the early 1990s, Australians – like the citizens of most developed economies – had got used to enduring a recession roughly every seven years.

But Macfarlane had been governor for 10 years, and had been extraordinary lucky to get through all that time without a severe downturn.

It was obvious to both men that Stevens wouldn't be as lucky. We were overdue for a recession and it was bound to occur sometime during Stevens' term, probably early on.

Except that it didn't. When, after his own 10-year stint, Stevens handed over to his government-chosen successor as governor, Dr Philip Lowe, in September last year, he was leaving the job with his record unsullied.

This time there were no forebodings about a doomed inheritance, even though it's only natural to fear that each successive quarter of this world record run must surely increase the likelihood of it coming to a sticky end.

Certainly, there would be few economists so foolhardy as to predict that their profession had finally conquered the booms and busts of the business cycle. Most remember that such bouts of hubris had afflicted – and in the end, mightily embarrassed – the dismal scientists before.

No one wants ultimately to be caught having made that stupid mistake a second time. So, a commercial message sponsored by your local friendly economist: rest assured, we'll have another bad recession sooner or later.

Human nature being what it is, keeping in the forefront of their minds the very real risk of another recession is the best way the managers of our economy can avoid the negligent overconfidence that could bring our record run to an ignominious end.

Of course, the politician with the strength of character to avoid complacency and self-congratulation for a remarkably good performance has probably yet to be born.

That's why this story began, and will continue, as a story about the people who have most say over the day-to-day management of the economy: not the politicians, but the bureaucrats in our central bank.

It's important to remember that Australia's run without a severe recession became a personal best, so to speak, many years ago, and for many years has exceeded the records achieved in all other developed countries – bar the Netherlands, with its freakish record of 103 quarters, almost 26 years, of continuous growth. Until now, as the world record passes to us.

An obvious question to ask is how Australia managed to avoid serious damage from the global financial crisis of 2008, when almost every other advanced economy was laid so low by the Great Recession.

The short answer is first that, thanks partly to the bureaucratic bum-kicking Peter Costello did after the collapse of the HIH insurance group in 2001, our bank regulators kept our banks under a tight rein, preventing them from doing all the risky things the American and European banks were allowed to.

Second, the Reserve Bank positively slashed interest rates the moment it realised the severity of the crisis, while the Rudd government ignored the dodgy advice it was getting from then-opposition leader Malcolm Turnbull and sections of the media, and splashed around a lot of cash.

Both the rate cuts and the cash splash had the intended effect of steadying the badly shaken confidence of businesses and consumers, thus quickly arresting the self-reinforcing downward spiral of fear and belt-tightening that causes all deep recessions.

Third, whereas many employers had previously responded to a downturn in demand for their product by laying off staff, this time many of them, hoping the downturn would be temporary, limited themselves to putting all their staff on a period of short-time working.

This restraint on the part of business proved a much less damaging approach for everyone.

But remember this: most advanced economies have suffered not one, but two or three deep recessions since the world recession of the early 1990s.

So there has to be more to our 26-year record than just our deft response to the GFC.

The deeper reasons for our success start with the factor already alluded to: our politicians' decision in the first half of the 1990s to hand control of interest rates to the central bank, acting independently of the elected government.

Turns out moving interests rates up and down in response to the business cycle, as opposed to the proximity of elections, is a big improvement in keeping the economy chugging steadily along.

The other beneficial change was all the "micro-economic reform" undertaken mainly during the term of the Hawke-Keating government, often with bipartisan support from the opposition, led by John Howard and Dr John Hewson.

Deregulating the financial system, floating the dollar, rolling back protection against imports, decentralising wage fixing and the deregulation of many particular industries had the combined effect of making the economy more flexible, less inflation-prone and better able to reduce unemployment.

The era of micro reform didn't achieve the hoped for continuing improvement in productivity, and had various adverse side-effects, but it did make it much easier for the central bankers to keep the economy on an even keel.

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How Treasury hides big infrastructure spending

One of the most significant, but least remarked upon, features of this year's budget is Malcolm Turnbull's decision to greatly expand the federal government's involvement in the construction of public infrastructure.

He did so under unprecedented and sustained public pressure from the Reserve Bank, seconded by the International Monetary Fund and the Organisation for Economic Co-operation and Development.

But how could the government be stimulating demand at a time when it still had a big budget deficit it needed to get back to surplus ASAP?

By distinguishing between the deficit arising from recurrent spending on its day-to-day operations, and the deficit arising from its investment in capital works, whose benefits to the community would flow for decades.

With the economy's downturn long past, the government should certainly be striving to get its recurrent finances – summarised by the budget's "net operating balance" – back to a healthy big surplus.

But no such stricture should apply to borrowing to improve the nation's infrastructure – always provided the money is well spent.

There's nothing new about this. The state governments have divided their budgets between operating expenses and investment in capital works for years. The national governments of New Zealand and Canada do the same.

So why haven't the feds been doing it? Because Treasury's never liked the idea. That's why, if you read the budget papers carefully, you find Treasury's found a way to do it and not do it at the same time.

The papers say they've always told us what the recurrent budget balance is, it's just that it's been buried somewhere up the back and called the net operating balance, or NOB.

But Treasury has had to admit that, for reasons that make sense only to accountants like me, the NOB regularly overstates recurrent spending by treating as an expense the cost of the feds' annual capital grants to the states to help with their infrastructure spending.

In the coming financial year, this overstatement is worth more than $12 billion, meaning the true recurrent deficit is actually quite small –  $7 billion – and expected to be back in balance in the following year, 2018-19.

So, no great worries there.

For the first time, Treasury has been obliged to reveal clearly exactly how much the feds have been, are, and expect to be, spending on capital works for the 14 years from 2007-08 to 2020-21 (see budget page 4.10).

In 2007-08, the last of Peter Costello's budgets, total federal capital spending was allowed to fall below $10 billion, but generally it's been between $30 billion and $40 billion a year. That's roughly 10 per cent of all the feds' spending.

But here's the big news: in the coming financial year, it's expected to rise to a (nominal) record of more than $50 billion, up from about $43 billion in the year just ending.

This will represent 12 per cent of total federal spending, and be equivalent to 2.8 per cent of gross domestic product.

Again for the first time, the budget papers give us the breakdown of the feds' total capital spending. First there's "direct capital investment" of $13.5 billion, which is mainly spending on defence equipment.

Next is "capital grants" of $14.2 billion. This is money given to other entities – predominantly, the state governments – to help them pay for their own capital works spending, mainly roads.

Last is an odd one, that Treasury usually prefers us not to notice: "financial asset investment (policy purposes)" worth $22.9 billion, up almost $6 billion on the year just ending, and the main cause of the coming big increase.

What's that financial asset investment thingy​? It goes back to 1996 and a loophole Treasury carefully built into the budget figuring at the time of the Charter of Budget Honesty (!) and the introduction of the "underlying cash balance" as the preferred measure of the budget's deficit or surplus.

Get this: if the government simply pays some private construction company to build some infrastructure for it, the cost is counted as part of the underlying cash deficit.

But if the government sets up its own company and gives it the same money, in the form of share capital or a loan, so the company builds the infrastructure (or pays another company to do it), the cost isn't counted in the underlying deficit.

Rather, it's tucked away in the "headline cash balance" that few people notice (see budget page 3.36). (The other big item stashed in the headline deficit is the net increase in the stock of HECS HELP student debt owed to the government, expected to be an extra $8 billion in the coming year.)

It's by this means that the Labor government was able to spend many billions constructing the national broadband network without a cent of it showing up in the underlying deficit.

In the coming year, the Turnbull government expects to buy $1.5 billion more in NBN shares and lend it $9.3 billion – all to finance further construction spending.

As well, it's setting up a company to own and build the second Sydney airport, and another to own and build the Melbourne to Brisbane inland freight railway.

Combined, these two new projects are expected to cost $1.8 billion in the coming year, rising to an annual $3.2 billion in 2020-21.

But if spending on infrastructure is now regarded as "good debt", why is Treasury still using this legal hair-splitting to conceal the cost of the new infrastructure spending push?

Because it's fighting a rear-guard action. Although it's agreed to give the NOB "increased prominence" in the budget papers, the underlying cash balance "will continue to be the primary fiscal aggregate".

And just to prove Treasury's lack of repentance, no modification has been made to the wording of the government's "medium-term fiscal strategy" to "achieve budget surpluses, on average, over the course of the economic cycle".

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FISCAL POLICY AND THE BUDGET

UBS HSC Economics Day, Sydney, Thursday, June 1, 2017

The annual budgets produced by federal governments usually have both political and economic objectives. But even if the objective of a budget is almost wholly political, the decisions taken in that budget will have inescapable economic implications. As you’ve learnt, the economic effects of a budget can be divided into three categories: the short-term effects on demand in the macro economy; the longer-term effects on the allocation of resources – that is, on the economy’s productive capacity, the supply side – and the eventual effects on the distribution of income between households.

This year’s budget’s main objective was highly political, intended to restore the Turnbull government’s standing in the opinion polls by pressing the reset button on the lingering unpopularity of Tony Abbott’s first budget in 2014. That budget proposed significant cuts in government spending – on pensions and benefits, and grants to the states for public hospitals and schools – that would have slowed the growth of spending over many years, with many not timed to begin until this year. In the event, the public judged these measures – many of which involved broken election promises – to be unfair, and most were blocked in the Senate. Even so, the government had determined to persist with them and kept them in the budget’s “forward estimates” of the budget balance in future years. Some wit dubbed these the “zombie” measures – they weren’t still alive, but they were undead.

The Abbott government’s standing in the opinion polls never recovered from the unpopularity of its first budget. The government’s stocks recovered briefly after the switch to Malcolm Turnbull, but soon fell back. This prompted the government to direct its next two budgets to restoring its political fortunes rather than pressing on with repair of the budget deficit. It limited itself to preventing its proposals for new spending programs from actually worsening the deficit by ensuring they were offset by equivalent savings in uncontroversial spending programs. This meant the government sat back to wait for the budget’s “automatic stabilisers” to bring the budget back to surplus as the economy continued to recover from the global financial crisis and the transition to growth in the non-mining sector after the mining boom. It was also hoping its decision not to have any further major cuts in income tax would hasten the return to budget surplus by causing a fair bit of “bracket creep” – or what economists call fiscal drag.

The centrepiece of last year’s budget, which came immediately before the 2016 election, was tax reform. The government proposed to cut the rate of company tax from 30 per cent to 25 per cent progressively over 10 years, starting with smaller companies and finally reaching big business. It covered some of the planned company tax cut’s cumulative cost of $48 billion over 10 years by a set of big increases in tobacco excise, cuts to superannuation tax concessions for high income earners and a new tax on multinational companies. In the event, the Senate agreed to pass only a cut in company tax rate of 27.5 per cent for small and medium businesses with annual turnover of less than $50 million.

The last thing I should tell you before we get down to business is that, for some years, successive governors of the Reserve Bank have been pressing the Coalition government for their monetary policy to be given more help from fiscal policy in its effort to stimulate demand and get the inflation rate back up into the 2 to 3 per cent target range. This is because it has become clear that, in present circumstances, monetary policy is much less effective in encouraging borrowing and spending than it used to be. The RBA has cut the cash rate many times since 2011, but growth remains below trend. The RBA explains this loss of effectiveness as the result of Australian households’ record level of debt, which discourages them from borrowing more even though interest rates are low. But how could fiscal policy help monetary policy lift spending at a time when the government is supposed to cutting the budget deficit and returning to surplus? By distinguishing between the government’s spending for recurrent purposes – that is, on the everyday operations of government – and its spending on investment in capital works (infrastructure). The RBA says the government should be getting the recurrent budget back to surplus as soon as it can, but this shouldn’t stop it continuing to borrow for worthwhile infrastructure, which should improve the economy’s productivity as well as adding to demand.

OK. Now let’s look at the government’s “framework” for the conduct of fiscal policy, before we take a closer look at this year’s budget.

Fiscal policy “framework”

Fiscal policy - the manipulation of government spending and taxation in the budget - is conducted according to the Turnbull government’s medium-term fiscal strategy: “to achieve budget surpluses, on average, over the course of the economic cycle”. This means the primary role of discretionary fiscal policy is to achieve “fiscal sustainability” - that is, to ensure we don’t build up an unsustainable level of public debt. However, the strategy leaves room for the budget’s automatic stabilisers to be unrestrained in assisting monetary policy in pursuing internal balance (low inflation and low unemployment). It also leaves room for discretionary fiscal policy to be used to stimulate the economy and thus help monetary policy manage demand, in exceptional circumstances - such as the GFC - provided the stimulus measures are temporary.

Recent developments in fiscal policy

As we’ve seen, this year’s budget was aimed at restoring the Turnbull government’s ailing political fortunes. Economically, its objective was to put the budget and the return to surplus on a stronger footing by accepting that this would require tax increases as well as spending cuts. It removed from the budget’s forward estimates unlegislated savings from the “zombie” spending cuts. This book entry worsened the expected budget balance by $2 billion in the budget year, 2017-18, with a total worsening of more than $13 billion over four years. Note, however, that the government has retained in the forward estimates its desire to extend the cut in the company tax rate to 25 per cent for companies of all sizes, by 2026-27. The new policy decisions announced in the budget – mainly involving tax increases - will have a negligible effect on the budget balance in the budget year, but yield a $20 billion improvement over four years.

The main revenue-raising measures are a small indirect tax on the liabilities of the five biggest banks; a further 0.5 percentage point increase in the Medicare levy in two years’ time, intended to cover the rising cost of the national disability insurance scheme; and increases in university fees, plus a lower income threshold at which former students must start to repay their debt.

The main measure on the spending side is the government’s acceptance of its own version of Labor’s policy for federal grants to non-government and government schools to be paid on the basis of students’ needs rather than on what schools received the previous year. Unlike Labor’s scheme, the government’s scheme involves cuts in grants to 24 highly overfunded private schools and a slower rate of growth in grants to about 300 somewhat overfunded private schools.

The budget papers project the underlying cash budget deficit falling from $38 billion (2.1 pc of GDP) in the old financial year to $29 billion (1.6 pc) in the coming year and reaching a tiny surplus in 2020-21, unchanged from last year’s budget. However, these figures don’t take account of   a net increase in infrastructure spending – on the national broadband network, the second Sydney airport and the inland railway - of about $5 billion, which has been hidden in the headline cash deficit. Allowing for all these factors suggests the “stance” of fiscal policy adopted in this budget is expansionary, but only mildly so. This does, however, represent a positive response to the RBA’s request for more help from the budget in stimulating demand, help that will grow as new projects get underway.

The government now expects the net public debt to reach a peak of 19.8 per cent of GDP in 2018-19. It is then projected to decline to 17.6 per cent by 2020-21.

Some economists have noted that the budget papers’ projected return to surplus in four years’ time, 2020-21, rests heavily on Treasury’s forecasts that annual wage growth will increase from 2 per cent in the financial year just ending (2016-17) to 3.75 per cent four years later in 2020-21. Such a strong recover in wage growth seems optimistic, at a time when Treasury’s forecasts have proved far too optimistic for six years or more.

There has been much debate about why it is taking far longer than expected to get the budget back to surplus. Some people blame the government’s reluctance to cut its spending – or the Senate’s rejection of so many of the cuts it proposed – but a more plausible explanation is the surprisingly slow recovery in tax collections, caused initially by the depth of the fall in export prices after 2011 and more recently by the exceptionally weak growth in wages, including the absence of much bracket creep.

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Governments share power with multitudinous lobbyists

You may think the media is full of the argy-bargy of politics, full to saturation point. There is, however, a level of politics we rarely hear about. You may not have noticed, but it raised its ugly head at the time of the budget earlier this month.

One sign was the anger, almost outrage, of the big banks when, on budget night, Scott Morrison surprised them by announcing a small new tax on them. Why weren't we consulted about this, they shouted.

Just a few days earlier, Education Minister Simon Birmingham surprised us by announcing the government's conversion to needs-based federal grants to schools, a la St David of Gonski.

The Catholic school authorities were deeply saddened. Birmingham's plan was to gradually unwind decades of special sectarian deals, the most recent of which had been made with the previous Labor government.

Why in Heaven's Name weren't we consulted before this unholy decision was made public, they cried.

When I heard both interest groups making their loud complaints I reacted the same way. Who the hell do these guys think they are?

You and I don't expect to be consulted before governments announce their policy decisions, so what gives these people the right to special treatment?

Well, I'll tell you: it's because that's the way they're used to being treated. Governments are considering making changes affecting a powerful and vocal interest group, so they – and more particularly, the top bureaucrats in the relevant government department – engage in private discussions with industry leaders and lobbyists.

If Birmingham decided on a new school funding arrangement without consulting the most-affected interest groups, it must have been because he knew they'd move heaven and earth in their efforts to ensure it didn't happen.

And, come to think of it, it's not all that unusual for new tax measures to be announced in the budget without prior consultation. You could justify this as necessary to ensure people aren't able to profit from inside information.

But I suspect it happens also because Treasury likes it that way. In the annual preparation for the budget, which goes on for months, Treasury ensures decisions about tax changes are made just days before budget night. That way, there's no time to consult and no time for ministers to be dissuaded from acting.

So the consultation happens after the move has been announced, when the government would lose face if it backed down too far.

Indeed, major tax and policy changes are invariably put into an industry consultation phase before being legislated. You can justify this practice by saying the world's become a complicated place and that the affected industry will always have an understanding of the practicalities of implementation that's superior to the bureaucrats'.

But there's more to it. I think industry representatives are routinely consulted on policy matters affecting them because, in practice, elected governments have come to share their power with a multitude of lobby groups.

You and I don't see the huge extent of contact that occurs between peak industry groups, consultant lobbyists and visiting executives, on one hand, and ministers, parliamentarians and bureaucrats on the other.

Indeed, we non-Canberrans don't realise the extent to which lobbying has become that city's second-biggest industry. That's particularly so if you include Canberra's small army of economic consultants, who earn their living by concocting "independent" modelling which, purely by chance, always seems to prove their clients' case.

And that's not counting the big four accounting firms which, when they're not doing "independent" modelling for the small fee, give extensive – and no doubt expensive – consulting advice on policy questions to government departments.

Why do they need such advice? Why is policy expertise moving from the public service to outside consultants? Because the yearly imposition of "efficiency dividends" on government departments means they keep getting rid of their policy experts. The words "false economy" spring to mind.

For an idea of just how big the lobbying industry has become, consider this. Buried in the budget was an announcement that the government had accepted the recommendations of a review of the financial system's arrangements for resolving external disputes.

Some lobby groups were unhappy with this decision, so last week they issued a press release saying so. It was issued in the name of six industry groups: the Mortgage and Finance Association of Australia, the Customer Owned Banking Association, the Australian Collectors & Debt Buyers Association, the Association of Securities and Derivatives Advisers of Australia, the Australian Timeshare and Holiday Ownership Council, and the Association of Independently Owned Financial Professionals (each with their own logo).

But if all the industry groups and other lobbyists did was issue press releases there would be little to worry about. Lobbying in public is just the tip of the iceberg. What matters is all the private contact with bureaucrats, ministers and politicians, particularly crossbench senators, we know nothing about.

Late last year I wrote prematurely about an eye-opening book by Dr Cameron Murray and Professor Paul Frijters, Game of Mates, which has finally been published.

The book reminds us that one way moneyed interests gain influence in the halls of power is by rewarding co-operative senior bureaucrats and politicians with post-retirement patronage. You too could be gamekeeper-turned-lobbyist.

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Our universities aren’t earning the money we give them

Sorry, but the small funding cuts imposed on the universities in the budget don't rouse any sympathy from me.

In an ideal world we'd be investing more in our universities, but our world is far from ideal. And so are our unis. They're inefficient bureaucracies, with bloated administrations and over-paid vice chancellors.

To hear them talk, you'd think unis were the fount of all economic virtue. According to Sydney University's Michael Spence, the budget was "an opportunity missed, because the government's done nothing about the significant cost of research and, of course, university research is fundamental to the innovation economy about which the government is so enthusiastic".

Sorry, prof, but the electorate's too well-educated to swallow such spin. The unis contribute to innovation, but it comes from other sources as well, and the unis' contribution should be better than it is without extra funding.

It's true our unis are obsessed by research, but any innovation this leads to is almost accidental. The research the unis care about is papers published in prestigious foreign journals, which they see as the path to what they're really striving for: a higher ranking on the various international league tables of universities.

Education Minister Simon Birmingham boasts that, on one table, six of our 43 unis are in the top 100, with nearly half in the top 300.

The pollies should stop doing this. It just encourages our "sandstone" unis – the self-dubbed Group of Eight – in their crazy, self-absorbed race.

Had Birmingham's predecessor succeeded in deregulating fees and let the sandstones exploit their monopoly pricing power, they would have delighted in overcharging their students and increasing students' cross-subsidy of the academics' research.

All of us should strive for excellence in our work, but when you start trying to force the pace with league tables and the dreaded KPIs – key performance indicators – you lose the plot.

You shift the rewards from intrinsic to extrinsic, and almost as much effort goes into trying to game the indicators of excellence as being excellent. The big rewards go to those who excel at appearing excellent.

Our big unis are so obsessed by research that academics' promotion is determined almost solely by how many papers you've had published and how prestigious were the journals you got into. Plus how much in research grants you've brought to the uni's coffers.

Apart from the time they spend thinking of ways to turn the same bit of research into more than one paper, our sandstone academics seem to spend more time applying for research grants than doing research.

Then there's the cultural cringe. The sandstone unis are filling their upper positions with sunshine-seeking Poms, Canadians and the odd eccentric Yank, in the belief they'll do better than the locals at getting published in prestigious international journals.

Our academic economists have even conned the federal government into spending taxpayers' money in ways that penalises those economists foolish enough to want to research the Australian economy.

That's because American journals won't publish articles about a small and boring country like ours, but our own journals don't rank in the unis' eternal quest for a higher international ranking.

Notice anything missing? Ah yes, all those students hanging around universities.

The unsatisfactory state of our unis is partly the product of our federal politicians' – Labor and Coalition – decades-long project to quietly and progressively privatise our universities via the backdoor.

Like so much misconceived micro-economic reform, this project hasn't worked well. Put a decades-long squeeze on unis' government funding and what happens? The unis intensify their obsession with research status-seeking and do it by exploiting their market power over students – while building ever larger bureaucracies.

There are some excellent teachers in universities, but they're the exception. The unis pretend to value good teachers – and award tin medals to prove it – but, in truth, there are no promotions for being a good teacher.

Students are seen as a necessary evil, needed because the public thinks teaching their kids is the main reason for continuing to feed academics.

Since Julia Gillard's spendthrift decision to remove the limits on how many uni places the government is prepared to fund, the unis have slashed their entrance requirements so as to rip as much money off the feds as possible.

Are they producing more would-be teachers or journalists or candlestick makers than the economy needs?

Who cares? All the unis know is that cramming more students into lecture theatres yields economies of scale that can be diverted to pay for more research – and pay for some part-time casual to do your teaching for you.

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How our budget repair problem has been exaggerated

Before the budget Scott Morrison promised us "good debt" and "bad debt". What we actually got was less radical but more sensible.

The government has come under increasing pressure from the Reserve Bank to draw a clear distinction between its borrowing to cover "recurrent" spending (on day-to-day operations) and borrowing to cover investment in capital works ("infrastructure").

It was wrong to lump them together and claim the combined deficit constituted the government "living beyond its means", as the Coalition often has.

Government borrowing to pay for infrastructure that will deliver a flow of services to the community for many decades to come is not in any way irresponsible.

The Reserve's reason for pressing the government was its desire for "fiscal policy" (the budget) to give its "monetary policy" (low interest rates) more help trying to stimulate faster economic growth.

Make the recurrent/capital distinction and the government can move to repair its budget and avoid unjustified borrowing, while still investing in new infrastructure projects that both add to demand in the short term, and later – provided the projects are well chosen – add to the economy's potential to supply more goods and services by improving our productivity.

In this budget Malcolm Turnbull finally capitulated to this pressure, overturning decades of Treasury dogma.

Sort of. Treasury's fought a rear-guard action, retaining the old world while seeming to move to the new.

In the process it's been obliged to make clear all the budgetary cupboards in which it hides the government's spending on capital works.

In so doing it has revealed that the line between budget accounting and creative accounting is thin.

Let's start with what in accounting passes as theory. There are two main ways you can measure the financial performance of an "entity" such as a business or a government: the rough-and-ready "cash" basis, or the more careful "accrual" basis.

The private sector has been using accrual accounting for more than a century, whereas Australia's public sector moved from cash to accrual only in 1999, after the United Nations Statistical Commission shifted the national accounts framework to an accrual basis in 1993 and the Australian Bureau of Statistics complied.

The cash basis measures the government's financial performance merely by comparing the cash it received during a period – usually a financial year – with the cash it paid out during the period.

By contrast, the accrual basis puts much effort into ensuring the incomings and outgoing are properly "matched", so they are allocated to the accounting period to which they rightly apply.

If, say, on the last day of the year you paid for an insurance policy to cover you for the following year, an adjustment would be made to shift that cost to the following year's accounts.

When the feds moved their accounts and budget onto an accrual basis at the turn of this century, however, Treasury declined to play ball.

It stuck with cash, making the debatable argument that recognising government transactions according to when the cash changed hands gives a better indication of those transactions' effect on the macro economy.

(It couldn't admit the real reason. The cash basis leaves much more scope for creative accounting: quietly moving receipts and payments between periods so as to make the books look better or hide something the government finds embarrassing.)

So, to this day, the budget papers are written in two different financial languages. The bit prepared by Treasury is written in cash, whereas the much bigger bit prepared by the Finance department is written in accrual – as it's supposed to be.

Get this: our bilingual budget means the budget papers offer us four different measures of the budget bottom line to pick from.

There's the "underlying cash" balance (the one Treasury wants us to focus on), the "headline cash" balance (please don't ask questions about this one), the "fiscal" balance (the close accrual equivalent of underlying cash) and, buried up the back, the accrual-based "net operating balance".

The news is that Treasury is sticking with underlying cash as "the primary fiscal aggregate" – the one it will make sure we focus on – but will ditch the fiscal balance (always just a face-saver cooked up by Treasury) and replace it with – give "increased prominence to" – the net operating balance, henceforth known as the NOB.

Bringing the NOB from the back up to the front will "assist in distinguishing between recurrent and capital spending" because, in accountingspeak​, "operating" and "recurrent" mean the same.

Point is, the biggest practical difference between cash and accrual is their treatment of spending on capital works. In cash, it's lumped in with recurrent spending, whereas in accrual it's not. Instead, accrual includes as a recurrent or operating expense an estimate of a year's worth of "depreciation" (wear and tear) of the feds' stock of physical capital – as it should if you believe in "matching" (which Treasury doesn't).

With this unprecedented casting of a spotlight on its accounting practices, Treasury has had to admit that the NOB actually overstates the recurrent balance because it includes as an expense the feds' capital grants to the states to help cover their spending on infrastructure.

Correcting for this reduces the coming financial year's NOB from a deficit of almost $20 billion to one of just over $7 billion (just 0.4 per cent of GDP). So we're already close to a balanced recurrent budget and should be there in 2018-19, after which (if Treasury's economic forecasts prove reliable) we'll be up to a recurrent surplus of $25 billion by 2020-21.

Turns out that, from the time the budget dropped into deficit in 2008-09 until the year just ending, focusing on the underlying cash deficit rather than the corrected NOB has exaggerated the extent of our budget repair problem by a cumulative $150 billion.

So how much have the feds been spending on infrastructure? Long story. Watch this space.

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