Confessions of a pet shop galah: much reform was stuffed up

As someone who, back in the day, did his share of being one of Paul Keating’s pet shop galahs – screeching "more micro reform!" every time they saw a pollie – I don’t cease to be embarrassed by the many supposed reforms that turned into stuff-ups.

My defence is that at least I’ve learnt from those mistakes. One thing I’ve learnt is that too many economists are heavily into confirmation bias – they memorise all the happenings that affirm the wisdom of their theory, but quickly cast from their minds the events that cast doubt on that wisdom.

Well, let me remind them of a few things they’d prefer to forget.

Of course, it’s not the case that everything done in the name of "micro-economic reform" was wrong-headed. The floating of the dollar was an unavoidable recognition that the era of fixed exchange rates was over. And the dollar’s ups and downs have almost always helped to stabilise the economy.

The old regulated banking system wasn’t working well and had to be junked. With the rise of China in a globalising world, persisting with a highly protected manufacturing sector would have been a recipe for getting poorer. Nor could we have persisted with a centralised wage-fixing system or a tax system that failed to tax capital gains, fringe benefits and services – to name just a few worthwhile reforms.

Many privatisations were justified – the government-owned banks, insurance companies and airlines – but the sale of geographic monopolies (ports and airports) and natural monopolies (electricity and telephone networks) was a step backwards, mainly because governments couldn’t resist the temptation to maximise the sale price by preserving the businesses’ pricing power at the expense of consumers.

The conversion of five state monopolies into the national electricity market proved a monumental stuff-up at all three levels: generation, transmission and retail. It quickly devolved into an oligopoly with three big vertically integrated firms happily overcharging consumers at every level, with collateral damage to the use of carbon pricing in reducing greenhouse gas emissions.

We’ve learnt that “markets” artificially created by governments and managed by bureaucrats are – you wouldn’t guess – hugely bureaucratic, with the managers susceptible to “capture” by market players. The gas market has also been an enormous stuff-up, threatening the survival of what remains of Australian manufacturing.

The ill-considered attempt to treat schools and TAFEs and universities as being in some kind of market, where fostering competition between them and paying teachers performance bonuses would spur them to lift their performance, proved an utter dud.

Had the harebrained plan to deregulate uni fees not been stopped, it would have made even worse the chronic disorientation of the nation’s vice chancellors on what universities are meant to do and why they’re doing it. Lesson: trying to turn non-market parts of society into markets, while blithely ignoring all the obvious reasons such "markets" would fail, is a fool’s errand.

Which brings us to the half-baked idea of trying improve the provision of taxpayer-funded services by making their delivery “contestable” by for-profit providers. It's been an expensive failure pretty much everywhere it’s been tried: childcare, employment services, vocational education and training, and aged care (see present royal commission), not to mention privately run prisons and offshore detention centres. How long will it be before we’re having a royal commission into the abuses of the largely outsourced national disability insurance scheme?

Why have so many reform programs ended so badly? Partly because of the naivety of econocrats and other proponents of "economic rationalism". They had no notion of how far the grossly oversimplified neo-classical model of markets they carry in their heads misrepresented the big bad real world.

And many of them, having spent their working lives solely in the public sector, had no idea of how wasteful or bureaucratic the supposedly rational private sector could be. Actually break the law if they thought they wouldn’t get caught because corporate law-breaking wasn’t being policed? Sure. Rip off the government because the bureaucrats wouldn’t notice? Love to.

But there’s another reason so many reforms blew up. Because naive econocrats failed to foresee the way reforms intended to leave consumers or taxpayers better off could be hijacked by Finance Department accountants looking to cut government spending and produce "smaller government" by whatever expediency possible (see uni fee deregulation) and politicians looking to win the approval of big business or to move money and influence from the public sector column (them) to the private sector column (us).

Lesson: if a venal politician can find a way to sabotage micro-economic reform to their own advantage, they will.

Read more >>

Weak wages the symptom of our stagnant economy, but why?

If you don’t like the term "secular stagnation" you can follow former Bank of England governor Mervyn King and say that, since the Great Recession of 2008-09, we’ve entered the Great Stagnation and are "stuck in a low-growth trap".

On Friday we saw the latest instalment of our politicians’ and econocrats’ reluctant admission that we’re in the same boat as the other becalmed advanced economies, with publication of the Reserve Bank’s latest downward revisions of its forecasts for economic growth.

This time last year, the Reserve was expecting real growth in gross domestic product of a ripping 3.25 per cent over the present financial year. Now it’s expecting 2.25 per cent. Even that may prove on the high side.

What their eternal optimism implies is our authorities’ belief that the economy’s weakness is largely "cyclical" – temporary. What the past eight years of downward revisions imply, however, is that the problem is mainly "structural" or, as they used to say a century ago, "secular" – long-lasting.

If the weakness is structural, waiting a bit longer won’t see the problem go away. The world’s economists will need to do a lot more researching and thinking to determine the main causes of the change in the structure of the economy and the way it works, and what we should be doing about it.

Apart from dividing problems between cyclical and structural, economists analyse them by viewing them from the perspective of demand and then the perspective of supply.

Obviously, what you’d like is demand and supply pretty much in balance, meaning low inflation and unemployment, with economies growing at a good pace and lifting our material standard of living. In practice, however, it’s not that simple and demand and supply don’t always align the way we’d like.

For about the first 30 years after World War II, the dominant view among economists was that the big problem was keeping demand strong enough to take up the economy’s ever-growing potential supply – its capacity to produce goods and services – and keep workers and factories in "full employment". Keynesian economics was developed to use the budget ("fiscal policy") to ensure demand was always up to the mark.

From about the mid-1970s, however, the advanced economies developed a big problem with inflation. After years of uncertainty and debate, the dominant view emerged that the main problem wasn’t "deficient" demand, it was excessive demand, always threatening to run ahead of the economy’s capacity to produce and thus cause inflation.

The answer was to get supply – potential production – growing faster. Most economists abandoned Keynesian economics and reverted to the former, "neo-classical" macro-economics, in which the central contention was that, over the medium-term, the rate at which an economy grew was determined on the supply side, by the three key determinants of production capacity, "the three Ps" – population, participation (by people in the labour force), and productivity – the rate at which investment in more and better machines and structures allowed workers to produce more per hour than they did before.

If so, the managers of the macro economy could do nothing to change the rate at which the economy grew over the medium term. Their role was simply to ensure that, in the short term, demand neither grew faster than the growth in the economy’s production potential (thus casing inflation) nor slower than potential (thus causing unemployment).

And the best instrument to use to achieve this balancing act was, as Treasury secretary Dr Steven Kennedy explained recently, monetary policy (moving interest rates up and down).

Everyone agrees that the problem with the advanced economies at present – including ours – is weak demand. The question is whether that weakness is mainly cyclical or mainly structural. If it's cyclical, all we have to do is be patient, and the old conventional wisdom - that, fundamentally, growth is supply-determined - doesn’t need changing.

But the conclusion that fits our circumstances better is that the demand problem has structural causes. Consider this: we’ve had plenty of episodes of weak demand in the past, but never has demand been so weak that inflation is negligible. Nominal interest rates are way down in consequence, but even real global interest rates have been falling since even before the financial crisis.

That’s why monetary policy has almost done its dash. It doesn’t do well at a time of negligible inflation, and fiscal policy is back to being the more effective instrument. But if the demand problem is mainly structural, then a burst of stimulus from the budget may help a bit, but won’t get to the heart of the problem.

As former top econocrat Dr Mike Keating has argued consistently, weak growth in real wages seems the main cause of weak growth in consumer spending and, hence, business investment, productivity improvement and overall growth – both in Australia and the other advanced economies.

Reserve Bank governor Dr Philip Lowe would agree. But he tends to see the wage problem as mainly cyclical: wait until we get more growth in employment, then the labour market will tighten, skill shortages will emerge and real wages will be pushed up.

Other economists stick to the supply-side, neo-classical approach: if real wages aren’t growing fast enough it can only be because the productivity of labour isn’t improving fast enough, so the answer is more micro-economic reform. Not a big help, guys.

The unions say the root cause is that deregulation has robbed organised labour of its bargaining power – and there may be something in that. But Keating’s argument has been that skill-biased technological change has hollowed out the semi-skilled middle of the workforce, with wage increases going disproportionately to the high-skilled, who save more of their income than lower-paid workers.

So Keating wants any budget stimulus to be directed towards the lower-paid, and a lot more spending on all levels of education and training, to help workers adopt and adapt to the digital workplace.

Read more >>

Mental health: the smart way to increase happiness

You have to hand it to Scott Morrison. He is, without doubt, the most skillful politician we’ve seen since John Howard. He runs rings around his opponents. It’s just a pity he puts so much time into strengthening his own position by making his opponents look bad and so little into strengthening our position by working on some of our many problems.

Speaking of problems, on the very day the Royal Commission into Aged Care was revealing how appallingly we treat so many of our parents and grandparents, the Productivity Commission released a draft report on how much our treatment of the mentally ill leaves to be desired.

Sometimes I think that if hastening the economy’s growth is intended to increase our happiness, why don’t we do more to increase it directly by reducing the unhappiness of, for instance, those in old people’s homes and those suffering mental illness, not to mention their families?

Why do you and I somehow imagine it won’t be us being mistreated in some institution in a few years’ time? Why could mental ill-health never reach us or our family and friends?

The commission’s report found that almost half of Australian adults will meet the diagnosis for a mental illness at some point in their lives. In any given year, however, one person in five will meet the criteria. And, although it can affect people of any age, three-quarters of those who develop mental illness first experience problems before they’re 25.

And yet we’ve gone for years providing quite inadequate help to the mentally troubled. Why? Because physical problems are more visible and less debatable. But also because the stigma that continues to attach to mental problems makes sufferers reluctant to admit to them, and the rest of us reluctant to dwell on it.

Mental illness includes more common conditions such as anxiety, substance use and depression, plus less common conditions such as eating disorders, attention-deficit/hyperactivity disorder, bipolar disorder and schizophrenia. And suicide, of course.

The report says that many who seek treatment for mental problems aren’t receiving the level of care necessary. As a result, too many people suffer additional and preventable physical and mental distress, relationship breakdown, stigma, and loss of life satisfaction (the $10 words for happiness) and opportunities.

A big part of the problem is that the treatment of mental illness has been tacked on to a health system designed around the characteristics of physical illness, especially acute rather than chronic illnesses.

Five long-standing and much-reported-on problems causing the mental health system to deliver poor results are, the report says, first, the underinvestment in prevention and early intervention. This is what makes the fact that mental problems tend to start early and get worse good news, in a sense. It means that, if you get in early, you can stop people experiencing years of unhappiness (not to mention cost to the taxpayer).

Second, the focus on clinical services – things done by doctors and nurses – often means overlooking other things and other people contributing to mental health, including the important role played by carers and family, as well as the providers of social support services.

Third, the frequent difficulties finding suitable social supports, sometimes because they just don’t exist in regional areas. This is despite suicide rates, for example, being much higher outside the capital cities.

Fourth, the social support people do receive is often well below best-practice, isn’t sustained as their condition evolves or their circumstances change, and is often unconnected with the clinical services they get.

Fifth, the “lack of clarity” about roles, responsibility and funding between the federal and state governments. This means persistent wasteful overlaps existing side by side with yawning gaps in the services provided. And it means no level of government accepts responsibility for “the system’s” poor performance.

It’s clear we’re not spending enough on mental healthcare. But this is where we get into an old argument. Ask the people running the system and their answer is always “just give us a shedload more money and we’ll decide how best to spend it”. But ask the Smaller Government brigade and they’ll say “we’re already spending far more than we did and spending even more would improve nothing”.

As usual, the truth’s in the middle. It’s true we’re spending a lot more without much evidence of improved results, but equally true we need to spend more – particularly on social support, such as suitable housing. Fix people, throw them onto the street, and see how well they do.

Sorry, but the days of “trust me, I’m a doctor/teacher/public servant/whatever” are gone. Too many occupations have abused our trust. We need to spend what we’re already spending a lot more effectively – particularly on prevention and early detection, on the non-clinical aspects of the problem, and on better coordination of federal and state roles – as a condition of spending more.

And that will mean paying a bit more tax. After all, if we’re so willing to spend on a big-screen TV or overseas holiday or new car to make us happier, what’s the hang-up with spending via taxes to improve our treatment in old age or should we or a rello strike mental problems?

Read more >>

Aged Care: the crappy end of the Smaller Government mentality

What do you get when politicians and econocrats go for decades trying to foist Smaller Government  on an unwilling public? Bad government. And the delivery of crappy services – often literally in the case of aged care.

The interim report of the royal commission into aged care is absolutely scathing about the appalling state the system has been allowed to fall into. Its summary is headed: 'A Shocking Tale of Neglect'.

Aged care services are “fragmented, unsupported and underfunded. With some admirable exceptions, they are poorly managed. All too often, they are unsafe and seemingly uncaring.”

“We have uncovered an aged care system that is characterised by an absence of innovation and by rigid conformity. The system lacks transparency in communication, reporting and accountability. It is not built around the people it is supposed to help and support, but around funding mechanisms, processes and procedures,” the report says.

“Many of the cases of deficiencies or outright failings in aged care were known to both the providers concerned and the regulators before coming to public attention. Why has so little been done to address these deficiencies?”

“We have heard evidence which suggests that the regulatory regime that is intended to ensure safety and quality of services . . . does not adequately deter poor practices. Indeed, it often fails to detect them. When it does so, remedial action is frequently ineffective. The regulatory regime appears to do little to encourage better practice beyond a minimum standard.”

Here’s where you see the fingerprints of the econocrats and accountants: “the aged care sector prides itself in being an ‘industry’ and it behaves like one. This masks the fact that 80 per cent of its funding comes directly from government coffers. Australian taxpayers have every right to expect that a sector so heavily funded by them should be open and fully accountable to the public and seen as a ‘service’ to them.”

Get it? Don’t ask us to publish performance indicators. They’re “commercial-in-confidence” – especially because many providers are for-profit providers. Why don’t the regulators insist? Because, like so many regulators, they’ve been “captured” by the providers, which have Canberra-based lobbyists, are generous wine-and-diners and employers of retired ministers and senior bureaucrats, and could make a lot more trouble for the government than a thousand mistreated mums aka silent Australians (whose vote for the Coalition is rusted-on).

The obvious reason the Smaller Government brigade has to shoulder the blame for the appalling treatment of so many (but not all) people in aged care – and many of the overworked and underpaid nurses working in it – is that, as part of the eternal crusade to keep government smaller, aged care is, as the commission finds, seriously underfunded.

But it’s worse than that. Part of the Smaller Government mentality is having aged care provided by someone other than the government – including for-profit providers which, as every Smaller Government crusader knows, are far more efficient than the public service.

Except that, as the commission’s report demonstrates yet again, they’re not. And when they can’t use greater efficiency to cover their profit margin, they extract it by cutting quality. The report doesn’t say so, but it’s a safe bet the for-profits are at the forefront of the “poor continence management,” “dreadful food, nutrition and hydration,” and “common use of physical restraint” and “overprescribing of drugs which sedate residents” to make them easier to manage, it uncovered.

Trouble is, so long as so much of the “industry” is profit-maximising, no amount of increased funding will be sufficient to stop residents being mistreated.

The more fundamental problem is that the Smaller Government zealots have never persuaded voters that less is more. Almost all of us think more is more. That’s what we want and what even conservative politicians promise us at every election.

So they have no mandate for Smaller Government and, since the disastrous 2014 budget, lack the political courage of their convictions. But they persist with their efforts to keep the lid on government spending, continually cutting away at the people they consider to be political weak and enemies of the Coalition: the ABC, people on welfare, and the deeply despised public service - particularly those bureaucrats offering policy advice (who needs it?) and those regulating and policing the public funding received by the party’s generous business donors.

In practice, Smaller Government means underspending on essentials such as aged care until the neglect is no longer tolerable politically, feigning shock and promising to spend big and crackdown on miscreants when voters react with horror to the revelations of the inevitable royal commission then, once the media circus has moved on, quietly welching on much of what you promised to do.

Read more >>

It may upset you to think about climate change and the economy

It’s coming to something when we get so little leadership from the bloke we pay to lead us that the unelected have to fill the vacuum. Now 10 business organisations have united to urge Scott Morrison either to set out the climate policy rules to drive action by the private sector, or end up spending a shedload of taxpayers’ money fixing the problem himself.

It’s not just business that’s dissatisfied. The Morrison government may be dominated by climate-change deniers, but almost all economists accept the science of global warming and believe we should be doing our bit to help limit it.

And though our elected government may be in denial, the Reserve Bank – like other central banks – isn’t. Nor are the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission.

The Queensland Treasurer, Jackie Trad, asked federal Treasurer Josh Frydenberg if the Reserve’s deputy governor, Dr Guy Debelle, could be invited to talk about climate change and the economy at the recent meeting of treasurers, but Frydenberg declined.

So what was it Frydenberg didn’t want his fellow treasurers thinking about? Well, we can get a fair idea of what Debelle would have said from a speech he gave earlier this year.

But first, why do so many economists accept the science? Because they know very little about the science and so accept the advice of the experts, especially since there’s so much agreement between them.

And there’s another reason. Economists believe they can use their expertise to help the community make the changes we need to make with the least amount of cost and disruption to the economy.

As Debelle reminds us, “the economics profession has examined the effects of climate change at least since Nobel Prize winner William Nordhaus in 1977. Since then it has become an area of considerably more active research in the profession. There has been a large body of work around the appropriate design of policies to address climate change (such as the design of carbon pricing mechanisms), but not that much in terms of what it might imply for macro-economic policies” – that is, for efforts to stabilise the macro economy as it moves through the ups and downs of the business cycle.

Debelle says the economy is changing all the time in response to a large number of forces, but few of them have the scale, persistence and risk to the system that climate change has.

Macro economists like to classify the various “shocks” that hit the economy as either positive or negative and as hitting the demand side of the economy or the supply side. For instance, they know a positive demand shock increases production (gross domestic product) and prices. The monetary policy response to such a shock is obvious: you raise interest rates to ensure inflation doesn’t get out of hand.

Shocks involving the climate affect the supply (output) side and are common. An unusually good growing season would be a positive supply shock, whereas a drought or cyclone or flood would be a negative supply shock, reducing output but increasing prices.

This is a trickier shock for monetary policy to respond to because it’s both contractionary (suggesting a cut in interest rates) and inflationary (suggesting higher rates). The Reserve’s usual response is to “look through” (ignore) the price increase, assuming its effect on inflation will be temporary.

Historically, the Reserve has assumed all climate events are temporary, with things soon returning to where they were. That is, they’re cyclical. It’s clear from the reports of the Intergovernmental Panel on Climate Change, however, that climate change is a trend - a lasting change in the structure of the economy, which will build up over many years.

Of course, though climate change’s impact on agriculture continues to be great, it presents significant risks and opportunities for a much broader part of the economy than agriculture.

Debelle says we need to reassess the frequency of climate events and our assumptions about the severity of those events. For example, the insurance industry has recognised that the frequency and severity of tropical cyclones has changed. It has “repriced” how it insures against such events.

Most of us are focused on “mitigating” – reducing – future climate change. But Debelle says we also need to think about how the economy is adapting to the climate change that’s already happened and how we’ll adapt to the further warming that’s coming, even if we do manage to get to zero net emissions before too long.

“The transition path to a less carbon-intensive world is clearly quite different depending on whether it is managed as a gradual process or is abrupt,” he says euphemistically. “The trend changes aren’t likely to be smooth. There is likely to be volatility around the trend, with the potential for damaging outcomes from spikes above the trend.”

Both the physical impact of climate change and the adjustment to a warmer world are likely to have significant economic effects, he says.

Economists know from their experience with reducing import protection that the change from the old arrangements to the new involves adjustment costs to some people (workers who have to find jobs in other industries, for instance) even if most people (consumers of the now-cheaper imports, for instance) are left better off.

Economists press on with advocating such painful changes provided they believe the gains to the winners are sufficient to allow them to compensate the losers and still be ahead. But Debelle admits that, in practice, the compensation to the losers doesn’t always happen, leaving those losers very dissatisfied.

That’s bad enough. But Debelle fears that, with climate change and the move to renewables, the distribution of benefits and costs may be such that the gains to the winners in new renewables industries aren’t great enough to cover the losses to the losers even in principle, let alone in practice.

Nah, all too hard. Let’s just ignore it and hope it goes away.

Read more >>

Health insurance: paying to boost specialists' incomes

I think I could probably get to the end of the year just writing once a week about the many problems Scott Morrison faces, but doesn’t seem to be making any progress on. And that’s before you get to climate change.

Take private health insurance. The public is terribly dissatisfied with it because it gets so much more expensive every year and because, when you make a claim, you’re often faced with huge out-of-pocket costs you weren't expecting.

The scheme has such internal contradictions it’s in terminal decline, getting weaker every year. Neither side of politics is game to put it out of its misery for fear of the powerful interests that would lose income – the health funds, the owners of private hospitals and myriad surgeons and other medical specialists – not to mention the anger of the better-off elderly who have convinced themselves they couldn’t live without it.

But neither is either side able to come up with any way of giving private health insurance a new lease on life. Anything governments could do – and probably will do – to keep the scheme going a bit longer involves slugging the taxpayer or forcing more people to pay the premiums.

I’ll be taking most of my information from the latest report on the subject by the nation’s leading health economist, Dr Stephen Duckett, of the Grattan Institute, but drawing my own conclusions.

Private health insurance is caught in a “death spiral” for two reasons. First, because the cost of the hospital stays and procedures it covers is rising much faster than wages are. Duckett calculates that, since 2011, average weekly wages have risen 8 per cent faster than general inflation, whereas health insurance premiums have rise 30 per cent faster.

Why? At bottom, because the health funds have done so little to prevent specialists raising their fees by a lot more than is reasonable. Federal governments have gone for years meekly approving excessive annual price increases.

Second, as with all insurance schemes, those policy holders who don’t claim cover the cost of those who do. The government’s long-standing policy of “community rating” means all singles pay the same premium, and all couples pay about twice that, regardless of their likelihood of making a claim.

This means the young and healthy subsidise the old and ill. Which would work if health insurance was compulsory, but to a large extent it’s voluntary. So the old and ill stay insured if they can possibly afford to, while the young and healthy are increasingly giving up their insurance.

The Howard government spent the whole of its 11 years trying to prop up health insurance with carrots and sticks. These measures stopped coverage from falling for a while but, with premiums continuing to soar, have lost their effectiveness.

Over the year to last December, the number of people under 65 with insurance fell by 125,000 (particularly those aged 25 to 34), while the number with insurance who were over 65 increased by 63,000.

So here’s the bind the funds are in: the more healthy young people drop out, the greater the increase in premiums for those remaining. But the more premiums increase, the more youngsters drop out.

The funds’ talk of being in a death spiral is intend to alarm the public into insisting the government bail them out by imposing more of the cost on taxpayers or, ideally, on young people. But before we panic, we should ask why we need the continued existence of private insurance.

After all, our real insurance is Medicare and being treated without direct charge in any public hospital. If the taxpayer-funded public system is less than ideal, it could be a lot better if the $9 billion a year the federal government tips into private insurance and private hospitals was redirected.

To some people, the big attraction of private insurance is “choice of doctor”. But this can be illusory. It’s usually your GP who does the choosing – to send you to one of their mates or their old professor. In any case, if people want choice, why shouldn’t they be asked to pay for it without a subsidy from the rest of us?

Ah, but the real reason I must have private insurance, many oldies say, is to avoid the public hospitals’ terrible waiting lists for elective surgery. That’s a reasonable argument for an individual, who can do nothing to change the system.

But it’s not a logical argument for politicians, who do have the power to change the system. And when the health funds claim that, without them, the waiting lists would be far longer, they’re trying to hoodwink us.

Most specialists work in both the public and private systems, but do all they can to direct their patients to private, where their piece rate is much higher. Were the health funds allowed to die, many fewer patients would be able to afford private operations and would join the public hospital waiting list.

But what would the specialists do to counter the huge drop in their incomes? They’d do far more of their operations in the public system, probably doing more operations in total than they did before. It’s even possible the queues would end up shorter than they are now.

Read more >>

Morrison hasn't noticed that economic times have changed

Apparently, if you think Scott Morrison's refusal to use the budget to boost the economy is motivated by an obsession with showing up Labor by delivering a huge budget surplus, you’re quite wrong.

No, he’s sticking to the highest principles of macro-economic management (which principles Reserve Bank governor Dr Philip Lowe doesn’t seem to understand).

We now know this thanks to the first speech of the new secretary to the Treasury, Dr Steven Kennedy, made last week. He explained to Senate Estimates the long-established orthodoxy among macro-economists in the advanced economies that "short-term economic weakness or unsustainably strong growth is best responded to by monetary policy" (interest rates) not fiscal policy (government spending and taxation).

Although the budget’s "automatic stabilisers" shouldn’t be prevented from assisting monetary policy in keeping growth stable, fiscal policy’s medium-term objective was to "deliver sustainable patterns of taxation and government spending".

Temporary fiscal actions should be taken only in "periods of crisis", which would be uncommon.

Now, I have to tell you Kennedy isn’t making these rules up. They did become orthodoxy in advanced-economy treasuries in the 1980s. They’re the reason John Kerin’s budget of 1991, delivered in the depths of "the recession we [didn’t] have to have" contained zero stimulus, meaning the stimulus, when it came in February 1992, came too late.

And it was the lesson he learnt from this stuff-up that prompted former Treasury secretary Dr Ken Henry to urge Kevin Rudd to "go early" after the global financial crisis in 2008.

These rules will have a familiar ring to those of us who each year study the fine print in budget statement 3 on the fiscal strategy. Particularly in the reference to the role of the budget’s automatic stabilisers, you see the fingerprints of Treasury’s leading macro-economist in recent decades, Dr Martin Parkinson.

Which is all very lovely. Just one small problem: the circumstances of the advanced economies – including ours – have changed radically since those rules were establish in the 1980s. They made sense then; they make no sense now.

For a start, how can you say, leave it all to monetary policy, when the official interest rate is almost as low as it can go? Has no one in the Canberra bubble noticed? Or do they imagine a switch from conventional to unconventional monetary policy tools would be seamless and involve no loss of efficacy or adverse consequences?

And since when did the orthodox assignment of roles between fiscal and monetary policies involve monetary policy resorting to unconventional measures?

The diminished effectiveness of monetary policy is a big part of the reason the world’s leading macro-economists have for some time been moving away from the old view that monetary policy was superior to fiscal policy as the main instrument for stabilising demand.

All those reasons are spelt out by Harvard’s Professor Jason Furman – a former chairman of President Obama’s Council of Economic Advisers – in a much-noted paper (summarised by me here). It was written as long ago as 2016, but doesn’t seem yet to have reached the banks of the Molonglo.

If there’s one thing macro economists know it’s that, these days, the economies of the developed world – including ours – don’t work the way they used to in the 1980s, or even before the financial crisis.

Interest rates are at record lows around the developed world not only because inflation is negligible but also because the world neutral real interest rate has been falling for decades and is now lower than it’s ever been.

This is linked to the fact – often referred to by Lowe, but not mentioned by Kennedy - that the supply of loanable funds provided by the world’s savers greatly exceeds the demand to borrow those funds for real investment.

Around the developed world – and in Australia – consumption is weak, business investment is weak, productivity improvement is low and real wage growth is low, while employment growth is stronger than you’d expect in the circumstances. Countries keep revising down their estimates of the "non-accelerating-inflation rate of unemployment" (that is, full employment), but no one really knows just how low it now is.

To give him his due, Kennedy’s speech reveals him to be just as puzzled as the rest of us about why the economy is behaving so differently.

But one thing seems clear: the private sector isn’t generating sufficient demand to get us out of "secular stagnation," so it’s up to the public sector to fill the void. And, sorry, but with monetary policy down for the count, that means using fiscal policy. They're the new, 21st century rules.

Read more >>

Treasury explains why we shouldn't worry about the economy

There’s a lesson for Scott Morrison in new Treasury secretary Dr Steven Kennedy’s first public speech this week: put the right person at the top of Treasury and they’ll defend the government’s position far more eloquently and persuasively than any politician could. The econocrat’s greater credibility demands they be taken seriously.

I fear that time will show it's been a costly mistake by the government not to respond to Reserve Bank governor Dr Philip Lowe’s unceasing requests for budgetary stimulus to supplement the diminishing effectiveness of interest rate cuts. Costly in terms of lost jobs – perhaps even including the Prime Minister’s.

But that Kennedy’s opening statement at Treasury’s appearance before Senate Estimates is a robust defence of official policy should surprise no one (except politicians, who are prone to paranoia). In my experience, senior Treasury officers never gainsay the government of the day, in public or private. If it’s an independent view you’re after, try the Reserve.

However, since this is the most ably argued exposition of the government’s case for sitting tight, it deserves to be reported in detail.

Kennedy is clearly worried about the threat to us from events in the rest of the world, but is
"cautiously optimistic" that the domestic economy will pick up. According to the government’s long-established "frameworks" for the respective roles of the two policy arms used to manage the macro economy – monetary policy (interest rates) and fiscal policy (the budget) – the heavy lifting is done by monetary policy, with fiscal policy being used only during a crisis. As yet, there’s no crisis.

Over the past year, Kennedy says, global growth has slowed. As a result, the International Monetary Fund and the Organisation for Economic Co-operation and Development now expect world growth this calendar year to be the slowest since the global financial crisis in 2008. Even so, they expect growth next year to improve to about 3 to 3.4 per cent – "which is still reasonable".

Chief among the factors involved are the ongoing and still evolving "trade tensions" between the United States and China. "There is no doubt that trade tensions are having real effects on the global economy, which you see in trade data from the US and China," he says.

Combined with other problems – Brexit, Hong Kong, and concerns about the financial stability of some countries – trade tensions are leading to an increased level of uncertainty around the outlook for the world economy.

Many central banks have responded to slowing global growth by supporting their economies. And South Korea and Thailand have also provided more supportive fiscal policy.

Turning to the domestic economy, it slowed in the second half of last year, then grew more strongly in the first half of this year. This amounted to growth of just 1.4 per cent over the year to June.

Household consumption, the largest part of the economy, grew by 1.4 per cent, held down mainly by weak growth in wages. Linked to this is a fall in home building over the past three quarters, which is likely to continue in the present financial year.

Moving to business investment spending, mining investment fell by almost 12 per cent over the year to June, and non-mining investment was weaker than expected.

But, Kennedy argues, these problems are temporary and "there are reasons to be optimistic about the outlook". Recent figures have shown early signs of recovery in the market for established housing. Overall, capital city house prices have risen for the past three months. Auction clearance rates have picked up and more homes are changing hands.

Consumer spending will be supported by the government’s tax cuts and the Reserve’s three cuts in interest rates.

The substantial investment in mining capacity of past years is boosting exports, and mining investment spending is expected to grow this year rather than contract, as it had been since 2012.

Despite modest growth in the economy, employment has continued to be strong, increasing by more than 300,000 over the past year. The rate of unemployment has been "broadly flat" rather than falling because near-record rates of new people are joining the labour force and getting jobs.

The rate of improvement in the productivity of labour – output per hour worked – has averaged 1.5 per cent a year over the past 30 years, but slowed to just 0.7 per cent a year over the past five. This isn’t as bad as it looks because it’s exactly what arithmetic would lead you to expect when employment is growing faster than output. And even 0.7 per cent is higher than the G7 economies can manage.

Now to the question of whether the government should be applying fiscal stimulus to guard against a recession.

Kennedy says that, in an open economy such as ours, having a medium-term "framework" (set of rules) for the way fiscal policy should be conducted, in concert with a medium-term framework for the way monetary policy should be conducted, "has long been held to be the most effective way to manage the economy through cycles".

Under this view, fiscal policy’s medium-term objective is to deliver sustainable patterns of taxation and government spending [and thus a sustainable level of public debt].  A further objective is usually to minimise the need for taxation, as is the case in Australia.

This approach reflects an assessment that apparent short-term economic weakness or, alternatively, unsustainably strong growth, is best responded to by monetary policy, not fiscal policy.

Within this framework, however, the budget’s in-built "automatic stabilisers" will assist monetary policy in stabilising the economy. For instance, revenue will weaken, and payments will strengthen, when an economy experiences weakness.

The other exception to the rule that fiscal policy should be focused exclusively on achieving sustainable public debt is that there’s a case for "temporary [note that word] fiscal actions" in periods of crisis.

But "the circumstances or crisis that would warrant temporary fiscal responses are uncommon".

So, sorry, Phil. Application denied.

Read more >>

Insincere, misguided displays of concern make the drought worse

Sometimes I think our politics has got into a vicious circle: the worse our politicians behave, the more of us give up and tune out. But the less we monitor their behaviour, the worse and more lackadaisical the politicians become.

Take the drought. Good politicians would see it as a recurring problem and try to find substantive ways of helping farmers cope with droughts in general; weak politicians settle for giving the impression of being very busy caring and helping – especially when the TV cameras are rolling – while they kick the problem down a country track.

Scott Morrison and his ministers keep announcing (or re-announcing) new measures to help, but the experts – including the National Farmers' Federation - keep lamenting that we don’t have a National Drought Policy and haven’t had one for years. We just keep knee-jerking and ad hocking every time another drought comes along.

So what would a decent national drought policy look like? It would start by reverting to an understanding the Hawke-Keating government established years ago, but has since been blurred: droughts aren’t a “natural disaster” in the way floods, cyclones and bushfires are. For a start, those others are sudden and short-lived, whereas droughts develop gradually, spread over huge areas and can last for years.

As Dorothea Mackellar realised more than a century ago, if you want to be an Australian, regular droughts are part of the deal. Always have been but, thanks to the two C-words we’re not supposed to say, are now likely to become more severe and more frequent. The day may come when not being in drought is the exception.

According to former top econocrat Dr Mike Keating, “the possibility of recurring droughts must therefore be planned for and not just treated as bad luck, for which farmers themselves bear no responsibility”.

The national drought policy of 1992 required farmers to be more self-reliant and absorb the impact of droughts as something to be expected. Many, many farmers have long been doing just that. Some haven’t bothered and they’re the ones getting most care and concern from fly-by-night journalists and politicians.

Everyone wants to “help those poor farmers”, but how should governments do it? John Freebairn, an economics professor at the University of Melbourne, says you can divide government drought support into three categories: subsidies for farm businesses, income supplements for low-income farm families, and support for better decision-making.

His message is that the main thing we should be doing is supporting programs to help farmers better manage the risk of drought and make their farms sustainable. Such support needs to come mainly between droughts – precisely when media and political interest in the topic evaporates.

Although income supplements for drought-stricken farmers raise questions about why they should get help other small-business people don’t, they’re a much more effective way of alleviating poverty than subsidising farmers’ loans, freight and fodder – which is just what federal and state politicians (and volunteer organisations) have been heaping on this time as the ad hockery has mounted.

As Professor Bruce Chapman, of the Australian National University, said this week, “the politics of drought is not only about helping farmers, [it’s] about showing the world – including city dwellers – that the government cares. It does that by giving money away and having lots of announcements.”

But here’s the less-obvious truth recognised by a considered drought policy: the too-ready availability of drought assistance helps create droughts.

How? By reducing “the risks associated with a bad year, and thus encouraging over-cropping and over-grazing. If farmers know that their mistakes will be bailed out, then they have an additional incentive to maintain their herds even when the risk of not having enough feed is quite high. They anticipate that the taxpayer will bail them out if it doesn’t rain, and that they will be able to buy in the additional (subsidised) fodder when they might need it,” Keating says.

Now get this: according to Lin Crase, an economics professor at the University of South Australia, “there is mounting evidence that farm businesses can actually benefit from drought in the longer term. This seems to occur because businesses that go through a drought develop coping strategies that, when invoked in good years, produce much greater profits.”

This doesn’t mean droughts are a good thing, of course, but it does mean that shielding farm businesses from drought runs the risk that they won’t adapt, Crase says. Changing climate suggests that a lot more adaptation – including bigger, more mechanised farms and many more farmers leaving the land – lies ahead.

Sensible drought policy long ago recognised that more dams don’t help, which is why so few have been built in recent decades. That politicians are popping up with plans for new dams is another sign they’re making it up as they go.

John Kerin, a minister for primary industry in the Hawke government, says that while you can fill new dams when you’ve eventually built them, “you can’t keep them full waiting for a drought, or empty waiting for a flood”. Increased stored water will be used to increase irrigation. And increased irrigation in a time of climate change means greater shortages of water in the next drought.

The expertise to respond to drought more sensibly is there. It’s just that our politicians find it easier pretending to fix the problem.

Read more >>

Morrison’s hang-ups make him a bad economic manager

Scott Morrison’s problem is that he gets politics – and is good at it – but doesn’t get economics.

The Prime Minister doesn’t get that if he keeps playing politics while doing nothing to stop the economy sliding into recession, nothing will save him from the voters’ wrath.

Neither he nor Josh Frydenberg seem to get that if we endure another year of very weak growth before they pop up next September boasting about their fabulous budget surplus, no one will be cheering.

How could a second financial year of weak growth possibly leave the budget with a big surplus? Because of the miracle of continuing bracket creep and iron ore prices kept high by BHP’s dam disaster in Brazil.

If there was any doubt about the likelihood of continuing weakness in our economy – independent of any adverse shock from abroad – it was swept away last week. The International Monetary Fund forecast real growth in Australia's gross domestic product of just 1.7 per cent this calendar year, improving only to 2.3 per cent next year.

So the IMF isn’t buying even Reserve Bank governor Philip Lowe’s “gentle turning point”, much less the efforts of Treasury’s seemingly unsackable Italian forecaster, Dr Rosie Scenario.

Frydenberg’s response has been that giving top priority to achieving a budget surplus isn’t just “a vanity exercise” because “a strong budget position helps build the resilience of the economy for external shocks, whenever that may occur, and your ability to respond to those stocks with a fiscal response”.

Translation: we can’t afford to spend money staving off recession because we’ll need to spend that money once we are in recession. The absurdity of this argument that a stitch in time doesn’t save nine has been hidden by his unstated assumption that, since the domestic economy's going fine, it’s only some shock from abroad that could lay us low.

Remember all the hand-wringing about quarter after quarter of weak growth in real wages, made even weaker – as Lowe has reminded us – by exceptionally strong growth in income tax collections? It’s imaginary, apparently.

Weak consumer spending, weak growth in business investment spending, contracting home-building? More imagining.

Oh yes, employment’s still growing surprisingly strongly. “See, I told you everything’s fine.” These guys are in denial.

Frydenberg’s argument about the need to “reload the fiscal canon” ready for the next downturn makes perfect sense - provided you’re paying back public debt at a time when the economy’s growing strongly and, if anything, could use a bit of slowing to ensure inflation doesn’t get away.

That's not us, unfortunately.

The IMF says “monetary policy [changing interest rates] cannot be the only game in town. It should be coupled with fiscal [budgetary] support where fiscal space is available, and policy is not already too expansionary”.

Far from being too expansionary, our fiscal policy is contractionary (which is why the budget balance is improving even as the economy slows).

And throughout the time that both sides of politics have been so worried about “debt and deficit”, the IMF has kept telling us not to worry because we have loads of “fiscal space” – that is, our level of public debt is way below the point where we should become concerned.

My bet is Morrison and Frydenberg will eventually panic and take stimulatory measures (probably a lot of them), but they’ll come too late in the piece to stop confidence unravelling, with punters tightening their belts as businesses lay off staff.

But not yet. Frydenberg has let it be known the government will try to boost business investment by introducing a special investment allowance – but not until the budget next May.

Even so, Finance Minister Mathias Cormann has let it be known that they’re thinking about turning the December midyear budget update into a mini budget if it soon becomes apparent the present tax and interest-rate cuts haven’t made much difference.

But even when that bullet is bitten, Morrison’s effectiveness as an economic manager will still be inhibited by his various political hang-ups. For instance, neither he nor his Treasurer can bring themselves even to utter the offensive S-word – stimulus.

And his determination never to be seen helping the poor (whom those in the party’s base know to be utterly undeserving) stops him taking two stimulatory measures that are simple, quick-acting and highly effective, while yielding lasting benefits.

The first is simply increasing the Newstart allowance.

The other is a proposal worked up by Dr Peter Davidson for the Australian Council of Social Service for the feds to invest $7 billion over three years building 20,000 social housing dwellings. This would not only boost growth and jobs in the becalmed housing industry, but also reduce homelessness.

Sorry, makes too much sense.

Read more >>