Friday, April 15, 2022

Digital revolution is leaving economists scratching their heads

There should be a law against holding election campaigns while people are trying to enjoy their Easter break. So let’s forget politics and think about the strange ways the economy is changing as the old industrial era gives way to the post-industrial, digital era.

The revolution in information and communications technology is working its way through the economy, changing the way it works. The markets for digital products now work very differently from the markets for conventional products.

So a growing part of the economy consists of markets that don’t fit the assumptions economists make in their basic model of markets, as Diane Coyle, an economics professor at Cambridge University, explains in her book, Cogs and Monsters.

And the way we measure the industrial economy – using the “national accounts” and gross domestic product – isn’t designed to capture the new range of benefits that flow from digital markets.

Starting at the beginning, the great attraction of the capitalist, market economy is its almost magical ability to increase its productivity – its ability to produce an increased quantity of goods and services from an unchanged quantity of raw materials, capital equipment and human labour.

It’s this increased productivity – not so much the increase in resources used – that explains most of the improvement in our standard of living over the past two centuries.

Where did the greater productivity come from? From advances in technology. From bigger and better machines, and more efficiently organised factories, mines, farms, offices and shops, not to mention better educated and skilled workers.

Particularly in the past 70 years, we benefited hugely from the advent of mass-produced consumer goods on production lines. Economists call this “economies of scale” – the bigger the factory and the more you could produce, the lower the cost of each item.

Although each extra unit produced added marginally to raw material and labour costs, the more you produced, the more the “fixed cost” of building and equipping the factory was averaged over a larger number of items, thus reducing the “average cost” per item.

Decades of exploiting the benefit of economies of scale explain why so many of our industries are dominated by just a few big firms.

But the new economy of digital production has put scale economies on steroids. Coyle says software – and movies, news mastheads and much, much else – is costly to write (high fixed cost) but virtually costless to reproduce and distribute (no marginal cost).

So, production of digital products involves “increasing returns to scale”, which is good news for both producers and consumers - everyone except economists because their standard model assumes returns are either constant or declining.

But another thing that makes the digital economy different is “network effects”, starting with the greatest network, the network of networks, the internet. The basic network effect is that the more users of the network there are, the greater the benefit to the individual user. More increasing returns to scale.

Then, Coyle says, there are indirect network effects. Many digital markets involve “matching” suppliers with consumers – such as Airbnb, Uber and Amazon Marketplace. For consumers, the more suppliers the network attracts, the better the chance of quickly finding what you want. But, equally, for suppliers, the more customers the network attracts, the easier it is to make a sale. Economists call these digital networks “two-sided platforms”. The owner of the platform sits in the middle, dealing with both sides.

So, yet more benefits from bigness. And that’s before you get to the benefits of building, mining and sharing large collections of data.

All these benefits being so great, it’s not hard to see why you could end up with only a couple – maybe just one – giant network dominating a market. Welcome to the world of Google, Facebook, Apple, Amazon and Microsoft.

In their forthcoming book, From Free to Fair Markets, Richard Holden, an economics professor at the University of NSW, and Rosalind Dixon, a law professor at the same place, note that a number of leading lights have proposed breaking up these huge tech companies, in the same way America’s big telephone monopoly and interlocking oil companies were broken up last century.

But, the authors object, in most of these markets the power of these giants stems from the “network externalities” we’ve just discussed.

“Unlike traditional markets, when the source of market power is also the source of consumer harm, in these markets the source of market power is also what consumers (and producers, in the case of two-sided platforms) value – being connected with other consumers and producers,” they write.

“The key driver of the value that these firms create is precisely the network externalities that they bring about. Facebook is valuable to users because lots of other users are on Facebook . . .

“Google is a superior search engine because in performing so many searches, machine learning allows its algorithm to get better and better, making it a more desirable search engine.”

So, the driving force that leads to these markets having one dominant player is also the force that creates economic value. “Breaking up the large players will stop there being just a few large players, but it will also stop there being nearly as much economic value created,” they say.

Research by Holden, Professor Luis Rayo and the Nobel laureate Robert Akerlof has found that markets with network externalities tend to have three features. First, the firm that wins the initial competition in the market ends up with most of the market.

Second, it’s difficult to become a winning firm, and success is fragile. For instance, Microsoft has had little success getting its search engine Bing to take business from Google. And Netscape was once dominant in the browser market, but suddenly got supplanted.

Third, winners can’t go to sleep. They must constantly innovate and seek to raise their quality.

This makes the tech markets quite different from conventional markets like oil or even old-style networks like railways.

Economists’ efforts to get a handle on the new economy continue.

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Wednesday, April 13, 2022

Let's use this election to raise the quality of the politics we get

This may be my 18th election as a journalist, but I confess I find the thought of a six-week campaign a bit daunting. Six weeks of unrelenting political argy-bargy?

Still, it does afford the luxury of one column discussing how we approach elections, before we get down to the many economic challenges the new government will face: climate change, wage stagnation, unaffordable home ownership and wasteful spending on infrastructure, not to mention integrity in government.

In elections, it’s always tempting to vote for the devil you know – a line pushed by all governments. But when you think about it, you see this notion is biased completely in favour of the incumbent. It seeks to shift the voter’s attention away from the government’s performance and play on our timidity.

What do you know about the other lot? Not much. How do you know they won’t be worse? You don’t. But, then again, they could be better.

If we always stuck to the devil-you-know rule, one side of politics would stay in power for ever. The other side would never get a go, and so would become more unknown – more unelectable – as each election passed.

Does that sound like the path to better government? Not to me, it doesn’t. In my experience, the longer governments stay in power, the worse they get. They get lazy and complacent. They worry more about helping their friends and less about keeping the rest of us happy.

They develop a sense of entitlement. They think they own the place and it’s their own money they’re spending. They get more and more reluctant to be held accountable by nosy outsiders and more inclined to keep their failures buried deep.

And that’s just the deterioration in government. The side kept out of power for year after year also goes off. Fewer and fewer of their leading lights have ever been a minister. They lose their corporate knowledge of how to run the country.

I’m old enough to remember the election of the Whitlam government in 1972, after 23 years in opposition. Wow, didn’t it show. And it wasn’t just their inexperience. They wanted to cram 23 years of “reform” into their first three years. Which, of course, is all they were given.

It wouldn’t be good for our governance if government changed hands every three or four years. But I long ago formed the view that no government – Labor or Liberal, federal or state, whether you voted for ’em or whether you didn’t – should be left in office for more than about 10 years.

With their ever-declining standards of behaviour, it’s tempting to give up on our politicians. “They’re all liars.” Actually, they rarely tell outright lies, though some do seem to have very bad memories.

What’s true is that they’re always saying things that are true from some limited perspective, but are calculated to mislead. “Record spending on health”, for instance, means provided you ignore inflation.

But when we give up on our politicians, it means they’ve won. They still get to run the place, but we’ve forfeited our right to a say in how it’s run. We’re happy for other people – including the pollies – to decide our fate. You want to make decisions that benefit your mates at my expense? Be my guest.

The trickier our politicians are, the more closely we should watch them. Whenever I speak to young people about politics, I warn them that the groups the politicians are most likely to screw are the ones that aren’t watching.

Another dangerous attitude is that there’s little difference between the two main parties. It’s true that both sides can be badly behaved, and that many policies are bipartisan. But there are differences between the parties’ approaches and, though the casual observer may find them hard to see, over time they do make a difference.

Paul Keating’s claim that when you change the government, you change the country, is right. Who we vote for in this election will change where we end up in 10 years’ time.

But the more the two major parties seem the same, the more people chose to vote for minor parties or independents – a trend likely to grow in this election. I regard this as a healthy development that will force the duopolists to lift their game.

As the number of independents grows, the possibility of a “hung” parliament increases. Both sides want us to believe this would be a bad thing, leading to instability. That’s the reverse of the truth. Minority governments are so common at state level that their presence goes unremarked.

And independents have a record of using their bargaining power to achieve reforms neither of the big parties fancy – fixed four-year terms in NSW, for instance – and moves towards greater transparency and accountability, such as freedom of information laws, and more resources for ombudsmen and auditors-general.

The way we vote in this election will make a difference. We should be using our votes to impose better quality governance on our wayward and self-serving political servants.

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Monday, April 11, 2022

Going ahead with the stage 3 tax cuts would be irresponsible

Whichever side wins the election will inherit a serious budget problem, one caused to a large extent by a single, irresponsible decision: to legislate years ahead of time for hugely expensive tax cuts in July 2024. Turns out they will be “unfunded”.

No one who professes to be terribly worried about the federal government’s huge and still-growing debt is genuine in their concern unless they’re prepared to pay a price for it: forgoing the tax cut that can no longer be afforded. Allowing the cut to happen will add significantly to the budget deficit and the further growth in our debt.

People who own a business that’s running at a loss, so to speak, shouldn’t be awarding themselves a pay rise that adds to the annual loss.

Putting it more formally, it was fully justified for the Rudd government to borrow heavily to cover the temporary measures that kept us out of the global financial crisis, just as it was fully justified for the Morrison government to borrow heavily to cover the temporary measures that saved life and limb during the worst of the pandemic.

But there is no justification for allowing the lasting spending increases and tax cuts made at the same time as the temporary measures to continue unfunded year after year, long after the crisis has passed and the economy has recovered.

A government that, having incurred so much debt through no fault of its own, continues to run a residual, “structural” deficit every year simply because it lacks the political courage either to make sweeping cuts in government spending or to ask the electorate to cover the full cost of services it doesn’t want cut by paying for them with higher taxes, simply cannot claim to be economically responsible.

It’s following a lax and unnecessarily risky practice should, say, a heavy fall in our export prices, cause the (nominal) economy to grow more slowly than interest rates, leaving us exposed when the next global crisis comes along.

That’s hardly fiscal conservatism. But the coming big tax cuts take us to a whole new level of irresponsibility.

Not only is the government afraid to ask voters to pay for the government services they demand, it’s trying to bribe its way to election by offering to make an unfunded cut in the tax they do pay, thus adding to the structural deficit and continuing growth in the debt, in both dollar terms and relative to the size of the economy that services the debt.

And the worst of it is that voting one irresponsible government out of office won’t avert the problem, just exchange that one for another. Both sides committed stage 3 to law in 2019, five years ahead of time, and Anthony Albanese has further promised to go through with it.

Here we see the worst of the games of chicken our politicians play in their unceasing attempts to “wedge” each other. Because both sides understand the game, their attempts rarely succeed. But the inevitable consequence is both sides agreeing to policies contrary to the public’s best interests.

Before the budget, Chris Richardson, Deloitte Access Economics’ great budget expert, estimated the ongoing structural deficit to be as high as about $40 billion – 2 per cent of national income. Because they’re legislated, this estimate includes the cost of the July 2024 tax cuts, whose cost he updates to be more than $21 billion a year.

See how central stage 3 is to the ongoing structural problem? Richardson notes that, because wages grew by far less that projected at the time stage 3 was announced, the cuts “now overachieve in handing back bracket creep”. That is, they’ll be “real” tax cuts, not just ones that restore the status quo.

Richardson could have added that stage 3 was never capable of achieving Scott Morrison’s advertised claim for it, that it would end bracket creep for almost all taxpayers. (You don’t have to literally change tax brackets to be a victim of inflation causing you to pay a higher average rate of tax on all your income.)

Richardson proposes that stage 3 be amended in one respect: keeping the marginal tax rate for those earning above $120,000 at 37¢ in the dollar – rather than reducing it to 30¢ – would cut the cost of the measure by (an amazing) $9 billion a year.

But why stop there when there’s so much more to be done? And when deciding not to do something you haven’t yet done is always easier politically than reversing something already done. And when not cutting taxes is infinitely easier politically than cutting existing entitlements to government spending.

Stage 3, first announced in the 2018 budget, was based on mere budget projections seven years into an unknown future - which included a pandemic. It’s a monument to the folly of counting your budgetary chickens long before they fail to hatch.

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Friday, April 8, 2022

Wars, floods and pestilence: these horrors have an economic upside

By profession, economists are hard-nosed and cold-blooded. The pictures we’re seeing of the death and destruction wreaked by Russia in its invasion of Ukraine are heart-wrenching. At home, seeing people perched on their roofs as floodwaters surge, or piling up the ruined contents of their homes on the footpath, makes your heart go out. But what economists see is that every disaster has its upside.

Once they’ve put on their professional’s hat, economists don’t see evil, or pain or any emotion. Feelings must be suppressed when what they need is objectivity.

They simply size up wars and natural disasters for the effect they’ll have on the economy, measured by inflation, unemployment and, above all, gross domestic product. And since GDP often ignores the destruction of buildings and other assets, but plays close attention to the building of new assets, it tends to paint an overly favourable view of events we see as disastrous.

This doesn’t make GDP an instrument of evil that should be banished. It’s simply mono-dimensional. It focuses on a vital, but narrow aspect of our lives – how much we produce, how much income we generate – while studiously ignoring all the other aspects.

When someone’s house has been declared uninhabitable, you and I see how painful and disorienting that must be for them. What an economist sees is all the jobs that will be created and income generated to build them a new one.

But until then, the family will be homeless! That’s OK. Those who provide them with somewhere to live will be earning income and employing people – provided they don’t just stay with family or neighbours. It’s not counted in GDP if no money changes hands.

GDP doesn’t measure wellbeing – and was never designed to. This is only a problem when people fall into the trap of thinking GDP is all that matters – an occupational hazard for economists.

Last week’s budget papers discussed the economic consequence of the war in Ukraine and the floods in NSW and Queensland. For such terrible events, the tone was surprisingly upbeat.

Combined, “the Russian and Ukrainian economies comprise less than 3 per cent of global GDP and less than 2.5 per cent of global trade.

“Foreign financial exposures to Russia are small, and the International Monetary Fund has assessed that sovereign [government] or bank default is not a systemic risk to global financial stability.”

Russia is, however, an important global supplier of rural, mineral and energy commodities. So the invasion has caused substantial disruption in global commodity markets, the papers say, and has the potential to significantly raise inflation and lower global growth.

“Russia produces 18 per cent of the world’s gas and 12 per cent of the world’s oil supply and, together with Ukraine, accounts for around 25 per cent of world wheat exports.” The invasion has increased the risk of supply disruptions, pushing up energy, agricultural and metals prices.

“Global supply chains are also reliant on Russian metals exports, especially palladium [a rare metal used in catalytic converters of exhaust fumes, and fuel cells], so significant supply disruption could have flow-on effects for global manufacturing supply chains.”

All economies will be affected by the rise in global commodity prices. Among the worst affected will be Europe, Japan and South Korea, which are highly dependent on imports of energy. These and other countries will suffer what economists call a “negative terms-of-trade shock” – that is, the prices of their energy imports will rise relative to the prices they get for their exports.

But, the papers say, a smaller set of countries will benefit from a “positive terms-of-trade shock” – because they are net exporters of the higher-priced energy commodities. Their consumers and businesses will pay the higher world price for the petrol and other fuels they use, but this will be greatly offset by the higher prices their producers of energy exports will be receiving.

Among this small group is one lucky country whose net energy exports are twice as great as its domestic energy use. It’s Austria. Sorry, make that Australia. As the economist Chris Richardson might say, you may be paying a lot more for your petrol, but the economy’s been kicked in the backside by a rainbow.

Turning to our floods, although it’s still raining and too soon for final figures, last week’s budget papers say that, under an arrangement where the federal government funds up to 75 per cent of the assistance provided by the state governments, the feds expect to pay more than $2 billion for income support to households, temporary accommodation and social services, about $600 million for community clean-up and recovery, and almost $700 million to businesses and farmers for repairs, new equipment and support services.

As well, the budget makes provision for $3 billion in further federal spending over the coming four years.

Moving from the budget to the economy, we’re told that the “direct economic cost” – that is, those purely monetary costs that show up in GDP – are expected to subtract about 0.5 percentage points from the growth in the nation’s real GDP during the March quarter.

What are the costs that show up in GDP? They’re mainly reduced production in the mining, agriculture, accommodation and food services, retail trade and construction industries.

You’ll be relieved to hear, however, that this 0.5 per cent overstates the net impact of the floods on real GDP over the longer term.

Why? Because “this direct cost will be partially offset by increased investment to replace and rebuild damaged housing, infrastructure and household goods”.

And here’s some good news: the reduced exports of coal caused by rain in the March quarter aren’t expected to be as bad as previous weather events, such as the floods and Cyclone Yasi in 2011.

If you find all this mercenary and distasteful, it’s not new. The arrival of World War II helped end the Great Depression. And rebuilding bombed out Europe and Japan after the war helped the rich countries grow faster than ever before – or since.

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Wednesday, April 6, 2022

Budget is a guide to who's a Morrison mate and who's not

Despite all the accusations being hurled at Scott Morrison, to my knowledge he’s never done what so many election-winning leaders do and promised to “govern for all Australians”. A promise not made, and thus not broken. All governments tend to look after their party’s friends and supporters, but Morrison has made this a defining feature of his reign.

There was a brief period early in the pandemic when he was in all-in-this-together mode. That was when, utterly uncharacteristically, he doubled the level of unemployment benefits – JobSeeker, to use its latest label – for a few months.

But it wasn’t long before it became clear he was playing favourites. The lockdown left many overseas students without part-time work and eligible for no government support. They were told to find their own way home, which many did.

Suddenly, the universities became public enemy No. 1. The same party that had gone for years urging the unis to find new sources of income and be less reliant on the federal taxpayer were attacked for becoming too reliant on revenue from overseas students.

While businesses large and small lined up for the JobKeeper wage subsidy scheme, our publicly owned universities were declared ineligible. Thousands of jobs were lost and, unlike with most other industries, are unlikely to return any time soon.

Our few privately owned universities were eligible, however. Similarly, public schools weren’t eligible, but independent schools were.

The government’s disdain for universities continued in last week’s budget. While Treasurer Josh Frydenberg was handing out prizes as though at a Sunday school anniversary, the universities got next to nothing.

True, the new “investing in Australia’s university research commercialisation payments” program will cost $1 billion over five years. But almost all of that will involve transferring money from existing programs.

The funny thing about the budget’s centrepiece, the cost-of-living package, is that though it doesn’t seem all that generous – a one-off $250 cash payment to pensioners and other welfare recipients, an extra $420 to those eligible for the low and middle income tax offset, and a 22c a litre cut in petrol excise for six months – at an overall cost of $8.3 billion it’s the most expensive new measure in the budget.

Because its intention is to mollify all those feeling pain from the recent jump in living costs, this is the most inclusive of the budget’s measures, with most families standing to benefit.

But though the $250 payment is aimed at those at the bottom of the income ladder, and the extra tax offset will help more than 10 million taxpayers, the cut in petrol excise will be of greater benefit to businesses and higher income-earners, simply because they use more petrol.

One group of big winners favoured in the budget are the tiny minority of people and businesses in the regions. Frydenberg announced “an unprecedented regional investment that includes transformational investments in agriculture, infrastructure and energy in the Hunter, the Pilbara, the Northern Territory and North and Central Queensland”.

Do you remember Barnaby Joyce’s Nationals demanding rural assistance in return for allowing Morrison to sign up to net zero emissions by 2050? At the time, the assistance wasn’t disclosed. Now it is.

They’re getting $7.4 billion for dams, a $2 billion “regional accelerator program” to accelerate growth in the regions, and a $1.3 billion regional telecommunications package to expand mobile coverage across 8000 kilometres of regional transport routes. Thanks a billion.

No budget would be a pre-election budget without further tax breaks to that huge voting bloc, small business. This time they’ll be getting a $120 tax deduction for every $100 they spend on training their employees, and on investment in digital technologies. That’s $1.7 billion over three years.

No doubt many small businesses will benefit from another measure to encourage more apprenticeships. The new apprentice gets $5000 and the employer who takes them on gets a wage subsidy of up to $15,000. I’ve read that tradies are the new key political demographic.

Sometimes, groups get special treatment not because they’re mates, but because governments fear offending them. A prime example are West Australians and their government. Under a deal done by Morrison when he was treasurer, because they’d convinced themselves they weren’t getting a fair share of the annual carve-up of GST revenue between the states, federal taxpayers will be paying the West Australians an extra $18.6 billion over the six years to 2025-26.

This despite the surge in iron ore royalties making Western Australia the only government in the land running a budget surplus. Tough times.

So, who wasn’t on the budget’s receiving end? The help for first-home buyers was token, and for renters, non-existent. There was a bit more to ease the continuing problems in aged care, but Frydenberg was easily outbid by Anthony Albanese.

Frydenberg has greatly reduced childcare costs for second and subsequent children, but Albanese is promising to make it free for virtually all families.

As voter loyalty to particular parties declines, politicians encourage a what’s-in-it-for-me approach to elections and pre-election budgets. If so, it’s important to know whether you’re a mate or a non-mate.

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Monday, April 4, 2022

Huge public debt isn’t the worry, it’s continuing budget deficits

There’s an easy way to tell how much someone understands economics: those at panic stations about the huge level of our government debt just don’t get it. But that’s not to say we don’t have a problem with the budget deficit.

Australia’s public debt isn’t high by international standards. It doesn’t have to be repaid by us, our children or anyone else. Since budget surpluses – which do reduce debt – have always been the exception rather than the rule, government debt is invariably “rolled over” (when bonds become due for redemption, they’re simply replaced with new ones).

The time-honoured way governments get on top of their debts is simply to outgrow them. So Treasurer Josh Frydenberg’s plan to reduce the relative importance of the debt by striving for strong economic growth is neither new nor radical.

If the debt panickers took more notice of what’s actually happening, they’d see that this approach is already bearing fruit. The remarkable strength of the economy’s rebound from the coronacession – much of which is owed to the success of the much-criticised JobKeeper scheme – is helping in two ways.

First, it’s causing the budget deficit to fall much quicker than expected, thus reducing the amount we’re adding to the debt in dollar terms. Second, the faster growth in the economy is slowing the growth of the debt in relative terms – that is, relative to the size of the economy that services the debt.

Most of the unexpected improvement in the budget balance has been allowed to stand, with only a small proportion of it used for further stimulus. That’s particularly true of last week’s budget, notwithstanding its blatant vote-buying.

The media have given us an exaggerated impression of the cost of those measures (particularly when you take account of the decision to discontinue the $8 billion-a-year low and middle income tax offset, which most of them failed to notice because there was no press release).

So the biggest burden present and future generations bear from the debt is the interest bill on it. But with interest rates at an unprecedented low, there’s never been a better time to borrow. And though it’s true long-term rates have started rising, they’ll still be unusually low for at least the rest of this decade.

What’s more, the average interest rate payable on the debt rises even more slowly because the higher rate applies only to the small part of the debt that’s being newly borrowed or reborrowed each year.

The budget’s gross interest payments are projected to stay below 1 per cent of gross domestic product until at least 2026. Which, as the independent economist Saul Eslake reminds us, means they’ll stay far lower than they were at any time in the 30 years to 2000. Frightening, eh.

Yet another point to remember is that the Reserve Bank’s resort to “quantitative easing” (buying second-hand bonds with created money) meant that, in effect, more than all the stimulus spending of the past two years was borrowed not from the public, but from another part of government, the central bank. It’s just a book entry.

But though there’s no reason to worry about either the level of the public debt or the interest bill on it, that’s not to say we can go on running budget deficits for another decade at least – which is what the budget papers project will happen “on unchanged policies”.

We had good reason to borrow heavily to protect ourselves from the global financial crisis and the Great Recession of 2008-09, and good reason to borrow heavily to save life and limb during the pandemic.

(The reason the debt continued growing between the two crises, was partly because we kept cutting income tax despite our continuing deficits, but also because economic growth was unusually weak.)

But what we shouldn’t be doing is continuing to run budget deficits after the effect of the temporary stimulus measures has ended. That is, we shouldn’t be running a “structural” deficit because we haven’t been raising enough tax revenue to cover the ordinary (but growing) business of government.

Some economists estimate the structural deficit is roughly $40 billion a year. Treasury’s projections show it falling steadily as a proportion of gross domestic product over the 10 years to 2032-33, but that’s owing to continued growth in the economy plus the no-policy-change assumption that the big tax cut in 2024-25 will be followed by eight years of bracket creep without further tax cuts.

One thing we should have learnt by now is to expect further unexpected major shocks to the economy that require further heavy borrowing. It would be imprudent to add to our debt, and use up borrowing capacity, merely because we didn’t feel like paying our way during the intervals between crises.

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Friday, April 1, 2022

Despite all the hoopla, budget's extra economic stimulus isn't huge

Sensible economists accept that, because they’re determined by politicians, budgets are more about politics than economics. Pre-election budgets are more political than other budgets. And budgets coming before an election a government fears it may lose are wholly politically driven.

Welcome to this week’s budget. But here’s the point: whatever the motivation driving the decisions announced in the budget to increase this or reduce that, all the decisions have an effect on the economy nonetheless.

It’s a budget’s overall effect on the economy that macro-economists care about, not so much the politicians’ motives. So good economic analysis involves leaving the politics to one side while you focus on determining the economic consequences.

A glance at this week’s budget says that, with all its vote-buying giveaways, the budget will impart a huge further stimulus to an economy that was already growing strongly, with unusually low unemployment, but rising inflation.

What on earth are these guys up to, ramping an economy that doesn’t need ramping just to try to buy their re-election? But glances are often misleading, and the story’s more complicated than that.

You can’t judge the “stance” of fiscal (budgetary) policy adopted in a particular budget – whether it will work to expand aggregate (total) demand (spending) in the economy or to contract demand – just by looking at the few of its many “measures” (policy changes) that hit the headlines, while ignoring the other hundred measures it contained.

And, as with many concepts in economics, there are different ways you can measure them, with the different ways giving you somewhat different answers.

The simplest way to judge the stance of policy adopted in a budget – it’s expansionary, contractionary or neither (neutral) – is the way the Reserve Bank does it. You just look at the direction and size of the expected change in the budget balance from the present financial year to the coming year.

Treasurer Josh Frydenberg expects the budget deficit for the year that will end in three months’ time to be $79.8 billion, and the deficit for the coming year, 2022-23, to be slightly smaller at $78 billion.

In an economy as big as ours, that decrease of $1.8 billion is too small to notice. The difference between how much money the budget is expected to take out of the economy in taxes and how much it puts back via government spending is expected to be virtually unchanged.

So, judging it the Reserve’s way, the budget will neither add to aggregate demand (total private plus public spending) nor subtract from it. The stance is neutral.

However, there’s a two-way relationship between the budget and the economy. The budget affects the economy but, by the same token, the economy affects the budget.

The size of the budget’s deficit or surplus is affected by where the economy is in the business cycle. When the economy’s booming, tax collections will be growing strongly, whereas government spending on unemployment benefits will be falling, thus causing a budget deficit to reduce (or a surplus to increase).

On the other hand, when the economy’s dipping into recession, tax collections will be falling and the cost of benefit payments will be rising, thus increasing a deficit (or reducing a surplus).

The Keynesian approach to deciding the stance of policy adopted in a budget is to distinguish between this “cyclical” effect on the budget balance – what the economy’s doing to the budget – and the “structural” effect caused by the government’s explicit decisions.

So, many economists believe that when assessing the stance of a new budget, you should ignore the cyclical component and focus on the change in the structural component – what the government has decided to do to the economy.

You can determine this by looking at what the great budget-expert Chris Richardson, of Deloitte Access Economics, calls “the table of truth”, table 3.3 of budget statement 3 in budget paper 1, page 18 in the PDF (page 86 in the printed version).

The table shows that in the few months since the mid-year budget update last December, the economy has strengthened more than expected - mainly because of the growth in consumer spending and employment but, to a lesser extent, because of the rise in the prices we get for our exports of coal and iron ore.

This means the cyclical component of the budget deficit (what Treasury calls “parameter and other variations”) is now expected to be $28 billion less in the present financial year, and $38 billion less in the budget year, 2022-23.

Adding in the “forward estimates” for three further years to 2025-26, gives a total expected improvement of $143 billion – all of which comes from higher-than-expected tax collections.

So, had the government done nothing in the budget, that’s by how much the string of five budget deficits would have been reduced, relative to what was expected last December.

However, the table also shows that the new policy decisions announced in the budget (and in the few months leading up to it) are expected to reduce that cyclical improvement by $9 billion in the financial year just ending, and $17 billion in the coming year.

These are additions to the expected “structural deficit”. Over the full five years, they should total $39 billion, with more than three-quarters of that total coming from increased government spending.

So, relative to where we expected to be in December, the government’s spending in the budget won’t stop the next five budget deficits – and the government’s debt – being more than $100 billion less.

Even so, judged in Keynesian terms, the government has added to the structural deficit, so the budget is expansionary.

The independent economist Saul Eslake calculates that the budget involves net stimulus equivalent to 0.4 per cent of gross domestic product in the present financial year, and 0.7 per cent in the coming year.

So, he concludes, “the budget does put some additional upward pressure on inflation...but it’s fairly small”.

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Wednesday, March 30, 2022

Sleight of hand: Frydenberg's disappearing cash trick

If you think this is a going-for-broke, pre-election vote-buying budget aimed squarely at the hip pocket of people worried about the rising cost of living, let me pass on Treasurer Josh Frydenberg’s grateful thanks. That’s just the impression he’s hoping you get.

But it isn’t true. When you read the fine print, you discover that, for most people, most of the cost of the extra help they will soon be getting will later be recouped by an increase in the income tax they pay.

True, low- and middle-income earners will get a one-off increase of $420 in their annual tax offset when they submit their tax return for this financial year (costing the budget more than $4 billion) and pensioners and other welfare recipients will benefit from the one-off $250 payment (costing $1.4 billion) that Mr Frydenberg will ensure hits their bank account before election day.

And every driver will save, thanks to the 22 cents a litre cut in the excise on petrol during the six months to the end of September. Coming at a net cost to the budget of $2.9 billion, it’s not to be sneezed at, even if the usual ups and downs of petrol prices will make it hard for many people to see the saving they’re making.

All this follows the old rule for politicians who put their political survival ahead of the public interest: make sure you look like you’re doing something about whatever is exercising voters’ minds at the minute, even if what you do makes little real difference to the problem.

But Mr Frydenberg has been trickier than that. Without needing to announce it – and hoping no one would notice – he has omitted to continue the low- and middle-income tax offset in the coming financial year.

This is his way of avoiding saying that the 10 million-plus taxpayers earning up to $126,000 a year will have their income tax increased by up to $1080 a year, from July 1. But they won’t feel it for at least a further 12 months, when they discover their tax refund is much smaller than they are used to.

Discontinuing this tax offset will increase tax collections by about $8 billion a year, thereby covering almost all the cost of the three temporary cost-of-living measures announced in the budget.

It’s a point worth remembering when next you hear Scott Morrison repeating his line that the Liberals are the party of lower taxes, whereas his opponents are the party of “tax and spend”.

So this budget is more about moving the budgetary deckchairs between years than significantly changing the government’s finances.

When you go beyond temporary handouts, the budget’s greatest weakness is Mr Frydenberg’s assurance that wage growth in the coming financial year will more than keep up with rising living costs. It is based on nothing more than optimistic forecasts.

The rise in consumer prices will slow from 4.25 per cent in the present financial year to 3 per cent in the coming year. Wages, on the other hand, will grow faster, from 2.75 per cent this year to 3.25 per cent next year.

Should this come to pass – and this government’s record on forecasting wage growth is woeful – it would mean that “real” wages grow by 0.25 per cent in the coming year, which would hardly make up for their expected fall of 1.5 per cent in the present year to the end of June.

If I were deciding my vote based on which side was promising to do more about the cost of living, I wouldn’t be greatly impressed. Whereas Labor is full of plans to speed up wage growth, the budget says nothing about changing wage-fixing arrangements.

The people most disapproving of the temporary cost-of-living relief are those sticking with the Coalition’s now-abandoned fatwa against debt and deficit. To them, reducing the debt must override all other objectives.

This was always based on the misconception that a national government’s finances work the same way a family’s do.

Mr Frydenberg is right in telling us that the best way to get on top of the government’s debt is to outgrow it.

Even so, he should be doing more to reduce the budget deficit in coming years – not because the government’s debt is dangerously high, but to give us greater safety should another global setback come along that yet again requires the government to buy our way out of trouble.

If Liberals were the great economic managers they claim to be, this budget would have included a plan to get started on largely eliminating the budget deficit. That means reducing the deficit by about $40 billion a year.

It didn’t. Which leaves us to wonder whether, should the Coalition be re-elected, its plans to cut government spending and increase taxes will be announced in its next budget, or whether it will continue avoiding unpopular measures and kicking our economic problems down the road.

Labor, on the other hand, is warning that, should it win the election, it will use a second budget to make improvements to this one. Of course, what counts as an improvement changes with the eye of the beholder.

The budget’s increased spending on the training and skills of apprentices and other young workers earns a big tick in my book.

One reason some may see the budget as profligate is its long list of $18 billion-worth of new infrastructure projects – big and small – being added to its much-mentioned record $120 billion infrastructure pipeline.

Many of these projects seem chosen to improve the Coalition’s vote in marginal electorates and few have been checked out and approved by the public service infrastructure experts.

Maybe this is an area where Labor would want to “improve” the list of lucky marginal seats.

But worriers should remember that, after the electioneering  is over, not every project that goes into the massive “pipeline” emerges from the other end. And many take much longer to emerge than the campaigning politician suggested they would.

This budget is not as fiscally responsible as the government would like you to believe when it’s claiming to be the party of good economic management. But nor is it as fiscally irresponsible as it would like you to believe when it is claiming to have fixed your problem with the cost of living.

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Sunday, March 13, 2022

Blaming the states for national policy failures won't wash

It seems everywhere you look you see governments failing to lead, failing to take charge, failing to be prepared for problems they should have seen coming.

Last week it was the flooding, before that, the distribution of rapid COVID testing kits and vaccines, before that, the Black Summer bushfires, and before that, soaring prices in the National Electricity Market along with the federal Coalition’s inability to agree on action to reduce greenhouse gas emissions.

The items on this seemingly disparate list have a few things in common. Most arise from the effects of climate change. All of them involve shared responsibility by the federal and state governments, with the all too familiar squabbling, duck-shoving and cost-shifting.

We’re learning hard lessons about what’s needed to get a better-functioning federation. One is that when ordinary Australians are facing dire emergencies of flood or fire or cyclone, they demand that both levels of government be on-the-job doing what needs doing.

Another lesson is that when you’ve got one federal, two territory and six state governments, one of them has to take the lead, and the one that should do so is obvious: the feds.

On climate change, it’s not just that the Morrison government has failed to do anything much to “mitigate” (reduce) our greenhouse gas emissions beyond belatedly accepting the target of somehow achieving net zero emissions by 2050.

It’s also that it has failed to lead the states in adapting to the climate change we already have and, even if we do make it to net zero on time, will get more of: worse and more frequent extreme weather events.

Why does Scott Morrison seem so bad at working on problems we can see coming, until they’ve actually arrived, and we’re in crisis? Then, when we are in crisis, he makes the excuse that it’s a “state responsibility”, which so infuriates the people left stranded by fire or flood.

I think part of the reason is his deliberate downgrading of public service advice on policy. Until recent years, it’s been a prime responsibility of department heads and their senior people to advise the minister of looming problems in their area of responsibility and to develop detailed options on how the feds – often in partnership with the states – could go about fixing the problem.

But when you tell the public servants that you want their diligent obedience, not their advice – as Morrison did – all you’re left with is advice from the growing number of ambitious young Liberal apparatchiks that populate ministers’ offices.

Plus, of course, the occasional expensive report from one of the big four accounting-turned-consulting firms, whose business model is to produce lovely reports with lots of glossy pictures, that tell the paying customer what you think they want to hear.

What they don’t want to be told is that they should get started on a response to this potential problem or that one, just in case they come to a head some time in the future. “That’s the boring stuff public servants are always banging on about, and it’s a real pain.”

“Do you know they’ve been harping on for years about being prepared for some possible pandemic? Yeah, sure. What other long-shot bet do you want me to waste money on? Talk about useless.”

The beauty of getting your advice from the young would-be-pollies in your office is that, like their masters, they’re always focused on the politics of the now. “How can we draw attention away from the latest stuff-up? How can we look like we’re responding decisively? Why don’t we rush through a law making illegal something that already is? The punters would love it.”

As soon as the election is called officially, the public service goes into “caretaker mode” and begins preparing extensive policy recommendations for the incoming government. They prepare a Blue Book to give the Coalition should it win, and a Red Book should Labor win.

The Grattan Institute, our leading independent think tank, has a tradition of preparing its own Orange Book, proposing policy priorities for whichever side wins. It includes a section on energy and climate change, one of the most important areas of shared, federal and state responsibility.

Grattan’s Tony Wood says that, one of the three things that should be done to ensure electricity plays its major role in achieving “net zero” is to “better co-ordinate state and federal government objectives in the National Electricity Market.

“Frustrated at a decade of federal ‘climate wars’, state governments are increasingly going their own way on electricity and gas [and electric vehicles],” Wood says.

That’s another lesson we need to learn: whenever the feds leave a policy vacuum, the states fill it – badly. Only leadership by the Federal government can make our ramshackle federation work.

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Friday, March 11, 2022

How to help the well-off: make their taxpayer assistance invisible

There’s a key principle of economics that’s not widely realised. Economists believe anything that looks like a duck and quacks like a duck must be a duck. Q: When is something that isn’t government spending still government spending? A: when it’s a tax break.

A government can impose taxes and spend the proceeds on achieving some objective – say, helping the retired with their living expenses – or it can achieve the same objective by charging those people less tax than they’d otherwise pay.

Whichever way the government chooses to do it, the effect on the budget balance is the same. And the effect on the people the government’s trying to help should be the same.

The only difference is that the two ways of assisting people appear on opposite sides of the budget. One adds to government spending while the other subtracts from government tax revenue. But, reason economists, this is a distinction without a difference. In principle, it doesn’t really matter.

Which is why economists have long sought to highlight the lack of difference between the two ways of assisting particular people or businesses by referring to special tax concessions as “tax expenditures”.

But though there may be no difference between the two in principle, in practice there’s an important difference. Government spending – on the age pension, for instance – is highly visible. It’s “salient” as psychologists and behavioural economists say.

By contrast, tax concessions – such as those applying to income that’s saved in a superannuation scheme, for instance – are much harder to see.

The practical consequence of this big difference in visibility is that actual government spending is examined carefully each year by the bureaucrats and by the Expenditure Review Committee of Cabinet, whereas all the spending on tax concessions tends to be ignored until someone decides to play around with a few of them.

This relative lack of attention paid to our many tax breaks prompted Treasury many years ago to begin estimating the value of the most important of them and publishing an annual Tax Expenditures Statement.

In 2019, however, the statement’s name was changed to the snappier, more enticing and informative Tax Benchmarks and Variations Statement. What a page-turner.

When the latest statement, for 2021, was published a few weeks ago, Dr John Hawkins, of the University of Canberra – in an earlier life, a senior Treasury official – used an article on the universities’ The Conversation website to explain that the name change reflects the truth that the amount of tax the government forgoes by granting a certain tax concession isn’t necessarily the same as the amount of tax it would regain if it abolished the concession.

Why not? Because when you make certain actions “tax-preferred”, people become more likely to take those actions, whereas when those actions cease to be tax-preferred people become less likely to take them.

But there’s another, less-defensible reason for switching to a title that will make tax expenditures even less visible than they already are. In the main, when governments want to help people in the bottom half of the distribution of incomes, they pay them money or buy things for them. But when governments want to help people in the top half of the distribution, they give them tax breaks.

(Hawkins points to one exception to that rule: the exemption of fresh food from the goods and services tax favours the poor over the rich because fresh food accounts for a higher proportion of the spending of the poor.)

If you’re well-off, and so have to pay proportionately more tax to support government spending to help those not doing as well as you are, it suits you for government spending to be highly visible and regularly scrutinised by politicians looking for ways to save money.

Conversely, it suits you for the support you get from the government to come in the form of tax concessions and thus be hidden from the public’s and the politicians’ view.

Hawkins notes that the biggest annual tax expenditures are: $64 billion because private homes are exempt from tax on any capital gain when they’re sold; $23 billion because the earnings on money in superannuation funds are taxed at a concessional rate; $21 billion because contributions to super funds are taxed at a concessional rate; and $12 billion because capital gains are taxed at only half the rate that income from “personal exertion” (work) is taxed.

Last financial year, the top 10 tax expenditures totalled just under $120 billion, which compares with total actual tax collections by the federal government of $460 billion. This year, 2021-22, the cost’s expected to be $150 billion. That increase of almost a quarter is explained mainly by the boom in house prices and share prices.

While tax expenditures primarily benefit the individual taxpayers who receive them, there’s a flow-on benefit to the industries conducting the economic activity that’s getting favourable tax treatment.

One stand-out is the property industry – developers, builders and real estate agents – which sees itself as benefiting from negative gearing and the 50 per cent discount on capital gains tax.

Another stand-out is the superannuation industry. It’s selling a product that’s heavily subsidised by the government – apart from the small fact that the government compels employers to buy its product on behalf of their employees.

The super industry has led claims that Treasury’s estimates of the value of tax expenditures are overstated. But Hawkins notes that its estimates of the revenue gained by canning a tax break don’t differ greatly from its estimates of revenue forgone.

A final “benefit” from the near invisibility of tax expenditures is that it allows recipients to delude themselves – and others – that they’re not dependent on government handouts.

John Roskam, boss of the Institute of Public Affairs, has written to correct my memory of an exchange between us more than a decade ago, as recounted in earlier editions of this column. I had written that the institute was “taxpayer-subsidised”. He wrote denying my claim. I replied that, since its donations were tax-deductible, this amounted to a subsidy from the taxpayer. He objected that I didn’t describe other government-supported organisations in this way.

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Wednesday, March 9, 2022

Why prime ministers do have to hold a hose (and much else)

If we don’t have another setback on the COVID front between now and May, it seems likely Scott Morrison will escape having his various fumbles in handling the pandemic loom large in the federal election campaign. Even so, the coronavirus was a stark reminder of how much the running of this nation is down to the premiers, not the Prime Minister.

The premiers took full advantage of this opportunity to raise their political profiles. And they’re likely to stay more assertive for years to come.

We’ve all lived all our lives with Australia’s federal system of government. We all know it doesn’t work so well. We long ago tired of the eternal bickering, buck-passing, duck-shoving and cost-shifting between the two levels of government. But just as we’re “learning to live with COVID”, so we long ago got used to living with a dysfunctional federation.

Does a nation of 25 million people really need one federal, six state and two territory governments? Well, if you were starting with a clean sheet of paper, you wouldn’t design it that way.

But we’ve never had a clean sheet. Back in the 1890s, we began with six self-governing colonies. They would never have agreed to dissolve themselves in to one national government. And, today, it’s not just that all those premiers and state parliamentarians wouldn’t want to give up their well-paid jobs.

The Australian mainland is such a big island, and its people are so widely spread around its coastal edge, I doubt if voters in any state would choose to be ruled henceforth solely from distant Canberra.

But the states being immovable, efforts by various prime ministers to make the system work better have had little success.

The pandemic has reminded us that our constitution grants to the states, not the feds, ultimate responsibility for most of the things we expect governments to do for us: healthcare, education, transport, law and order, housing, community services and the environment. Only the states and territories had the constitutional power to order lockdowns or close state borders.

But the problem isn’t just constitutional. It’s also economic. It’s what economists call “vertical fiscal imbalance”. Over the years – and with much help from rulings of the High Court – the feds have accreted to themselves most of the power to levy taxes.

See the problem? The feds raise most of the tax revenue, whereas the states have most of the responsibility for spending it.

Economists think the federation would work better if there was a closer alignment between each level’s spending responsibilities and its tax-raising capacity. But prime ministers haven’t been keen to hand over their taxing powers.

The bigger problem with VFI, as the aficionados call it, isn’t economic, it’s political: the feds cop the blame for levying nasty taxes; the states get the credit for lots of lovely spending. The states love it, the feds hate it.

Related to this is a truth that seems to come as a shock to prime ministers. The feds run defence and foreign affairs and customs and trade. Apart from that, they raise taxes and write cheques – to the premiers, universities, chemists and bulk-billing doctors, pensioners and people on unemployment benefits.

What the feds don’t do much of is deliver programs on the ground, whereas that’s the main thing the states do. Run hospitals and schools, build highways, fight bushfires and clean up after floods.

Turns out that when the feds do try to deliver programs on the ground – put pink batts in ceilings; roll out vaccines across the land – they stuff it up.

In all this you have the hidden explanation for some of Morrison’s coronafumbles.

Despite him setting up the national cabinet – and doing most of the on-camera talking after each meeting – it turned out that most of the credit for our success in handling the pandemic went to the premiers, not him. “What? Even though the feds were picking up almost all the tab?”

Apart from the feds’ failure to order enough vaccines early enough, it seems clear Morrison decided to deliver them through an essentially federal distribution chain of GPs and pharmacists, in the hope this would yield him more of the credit.

That’s how the rollout became a stroll out. It was slow and unfamiliar. Only when the feds admitted defeat and started distributing vaccines through the experts – the states’ public hospitals and mass-vaccination hubs – did things speed up.

I suspect other hold-ups – in replacing JobKeeper; in distributing rapid antigen test kits – came because the feds and states fell to arguing over how the bill should be divvied up. “Why am I paying when you’ll be getting all the credit?”

Morrison said what he did about hoses because bushfires are a state responsibility. Constitutionally, correct; politically, incorrect. He’s had to learn the hard way that if a state problem affects more than one state – or just gets too big for the state to cope with – it becomes a federal problem in the minds of voters.

If you can’t hold a hose, just bring your chequebook.

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Monday, March 7, 2022

It will take more that faith to keep the economy growing

Treasurer Josh Frydenberg says it’s time for the private sector to drive the economy’s recovery. And, this being a Liberal Party article of faith, he’s likely to keep saying it in this month’s budget and the election campaign to follow. One small problem: there’s little sign it’s happening.

Last week’s national accounts for the December quarter were a reminder that the economy’s living on borrowed time and stored heat. Both households and businesses are cashed up as a result of “fiscal stimulus” – government income support – and income they weren’t able to spend during lockdowns.

It’s estimated that households have an extra $200 billion or more waiting to be spent. As it is spent, private consumption will continue growing strongly in real terms. But, absent further lockdowns, there’ll be no more special support from the budget. No more JobKeeper payments and the like, no more grants to encourage home building, and a looming end to tax breaks to encourage business investment in equipment and construction.

The two main things we need to achieve continuing strong economic growth (by which I mean growth in income per person, not just more immigration) is strong real growth in household consumption spending and business investment spending.

Trouble is, last week’s figures offered little assurance that either requirement will be forthcoming. Starting with business investment, Kieran Davies, of Coolabah Capital, reminds us that (even after including intangible investment in software and research and development) it’s presently at the “extraordinarily low” level of 10 per cent of gross domestic product, similar to the lows it reached in the recessions of the 1970s and 1990s.

It may be about to take off – or it may not be. It’s hard to think why a take-off is likely. Davies reminds us that a major benefit from a big lift in business investment would be a lift in the productivity of labour, as workers were supplied with the improved equipment they need to be more productive.

Indeed, you can turn the argument round the other way and wonder if the weak rates of business investment over the past decade or so do much to help explain why productivity has improved so little over the period.

Even the most tightwad employer must agree that improved labour productivity means wages can rise faster than prices without adding to inflation.

And if we want to see consumer spending, which accounts for well over half of GDP, continuing to grow strongly once all the money households saved during the pandemic has been spent, rising real wages are the only thing that will do it.

Trouble is, the (temporary) surges in consumer spending whenever we end a period of lockdown have given the impression the economy is booming, while concealing the truth that, after allowing for inflation, wages have been falling, not rising.

This is also reflected in last week’s news from the national accounts that “non-farm real unit labour costs” – which, by comparing the change in firms’ real labour costs with the change in the productivity of that labour, reflect the division of surplus between labour and profits – have fallen by 3 per cent since the start of the pandemic.

This should not come as a surprise when you remember that, in early 2020, when we feared the battle to control the virus would send us into a deep and lasting recession, most businesses moved immediately to impose a wage freeze.

Worried about whether the deep recession would sweep away their jobs, workers and their unions accepted the necessity of the freeze.

But that’s not the way things turned out. The pandemic wasn’t nearly as bad as epidemiologists first expected it to be, vaccines turned up much earlier than had been hoped, lockdowns were often short and intermittent, and unprecedented fiscal stimulus shifted much of the cost of the lockdowns off private businesses’ profit and loss accounts and onto the public sector’s budgets.

In the main, private sector profits have held up surprisingly well.

So the key issue of whether consumer spending, and thus the wider economy, can continue growing strongly after households have finished the spending repressed during the lockdowns is what happens to wage growth. And that comes down to three questions.

First, will employees get outsized pay rises this year to compensate them for the wage freeze that turned out not to be needed?

Second, will employees also get pay rises big enough to cover all the recent increase in living costs they face – higher petrol prices and the rest – or will employers, public as well as private, ask them to “take one for the team” one more time? If so, real wages will fall further and future consumer spending will be stuffed.

Third, will the econocrats’ strategy of running a super-tight labour market force tight-fisted employers to increase wages, as the only desperation measure able to attract the workers they need?

Or will the labour shortages gradually dissipate now our border’s been reopened to overseas students, backpackers and skilled immigrants on temporary visas?

Meanwhile, the man who should be solving our cost-of-living/weak wages problem will be blustering on about the private sector taking over the running. If the Opposition can’t make this the central focus of the election campaign, it deserves to lose. It, too, would be bad at managing the economy.

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Saturday, March 5, 2022

The plague hasn’t wounded the economy, but the boom won’t last

The pandemic has caused much pain – physical, financial and psychological – to many people. But what it hasn’t done is any lasting damage to the economy and its ability to support people wanting to earn a living.

That’s clear from this week’s “national accounts” for the three months to the end of December, with the Australian Bureau of Statistics revealing the economy’s production of goods and services – real gross domestic product – rebounding by 3.4 per cent, following the previous quarter’s contraction of 1.9 per cent, caused by the lockdowns in NSW, Victoria and the ACT.

Despite those downs and ups, the economy ended up growing by 4.2 per cent over the course of last year. It was a similar story the previous year, 2020, when despite the nationwide lockdown causing the economy to contract by a massive 6.8 per cent in the June quarter, it began bouncing back the following quarter.

Over the two years of the pandemic, the economy’s ended up 3.4 per cent bigger than it was before the trouble started.

Be under no illusion, however. The economy would not have been able to bounce back so strongly had the federal government not spent such huge sums topping up the incomes of workers and businesses with the JobKeeper wage subsidy, the temporary increase in JobSeeker benefits, special tax breaks for business (including to encourage them to invest in plant and equipment) special incentives for new home-building, and much else. The state governments also spent a lot.

The Reserve Bank also cut interest rates – from next-to-nothing to nothing – and bought a lot of government bonds, but I find it hard to believe this made a big difference, except to house prices and home building.

It’s true that these figures for GDP and its components don’t include the effects of the Omicron wave, which came mainly in the first half of January. But by now it’s pretty clear its effect on the economy was fairly small. Of course, we may not be finished with the Greek alphabet.

None of this is to deny that the pandemic has done lasting damage to some individual workers, businesses and industries. Overall, however, the economy’s in surprisingly good shape. And this is confirmed by turning from the national accounts to the jobs market.

We have 270,000 more people in jobs than we did before the pandemic, and both unemployment and underemployment are at 13-year lows, while the number of job vacancies is at a record high.

This remarkable achievement is partly the consequence of shortages of young, less-skilled workers, caused by our closed border, however. Those shortages will gradually go away now the border’s been reopened.

Unsurprisingly, the detailed figures show that most of the growth during the quarter came from a rebound in the two unlocked states, NSW and Victoria, plus the ACT.

More surprisingly, most of the growth came from a rebound in consumer spending in former lockdown area, which rose by 9.6 per cent, compared with 1.6 per cent in the rest of the country.

The only other positive contribution to growth in the quarter was a rise in the level of business inventories – meaning the rest of the economy was holding it back.

Spending on new housing and alterations fell by 2.2 per cent in the quarter, mainly because of temporary shortages of workers and materials.

The government’s stimulus program has ended, but the industry still has many new houses in the pipeline. However, Thursday’s news of a 28 per cent collapse in the number of new residential building approvals in January makes you wonder how long the housing industry will keep contributing to growth.

Business investment in new equipment and construction also fell during the quarter. Businesses say they’re expecting to increase their spending significantly this year but, as Kieran Davies, of Coolabah Capital, has noted, “companies find it hard to forecast their own investment expenditure”. And the government’s tax incentives won’t last forever.

The jump in consumer spending came despite a fall in households’ disposable income, caused by a decline in assistance from government. Thus, to cover the increased spending, households had to cut their rate of saving during the quarter from almost 20 per cent of their disposable income to 13.6 per cent.

What’s been happening is that households save a huge proportion of their income during lockdowns (because they can’t get out of the house to spend it), but cut their rate of saving when the lockdown ends and spend much more than usual as they catch up on things and services they’ve been waiting to buy.

Even so, a saving rate of 13.6 per cent is about twice the normal rate - meaning households still have a lot of money stashed in bank accounts – more than $200 billion – that they’ll be able to spend in coming months.

Most of this is money they’ve earnt in the normal way, but much of it is also money that’s come to them in special assistance from the government.

It’s mainly because of all this extra money waiting to be spent that the Reserve Bank is forecasting that, after contracting by about 1 per cent in 2020 and growing by 4 per cent in 2021, the economy will grow by a bit more than 4 per cent this year.

Remember, however, that the economy usually grows by only about 2.5 per cent a year. So what looks like booming growth last year and this, is really just catch-up from the temporary effects of lockdowns.

We simply can’t – and won’t – keep growing at the rate of 4 per cent a year. That’s why the Reserve is expecting growth to slow sharply to a more-normal 2 per cent next year, 2023.

Most of the extra money households are holding may have been spent by the end of this year. And the forecast for 2023 assumes we’ll be back to wages growing a bit faster than the cost of living – which has yet to happen.

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Tuesday, March 1, 2022


You may be appalled by the ever-declining standards of propriety as the two main parties chase each other to the bottom of the barrel, putting career advancement ahead of their duty to voters. But recent events show our courageous auditors-general haven’t lost their commitment to upholding honest behaviour.

Which, particularly in the absence of a federal independent commission against corruption, is one thing to be thankful for.

Just last week in NSW, state Auditor-General Margaret Crawford issued a highly critical report on the Stronger Communities grants program established by the Berejiklian government before the 2019 state election.

The report said there was “little or no [defensible] basis” for the selection of grant recipients, with 95 per cent of all grant money flowing to 22 local councils belonging to Coalition electorates. These decisions were made by the former premier and her deputy, Gladys Berejiklian and John Barilaro.

This is reminiscent of federal Auditor-General Grant Hehir’s equally critical 2020 report on the “sports rorts” grants made by the Morrison government before the 2019 federal election. He found that the Australian Sports Commission’s carefully evaluated recommendations for grants were overridden by the minister’s office.

More than 61 per cent of the grants awarded failed to reach the commission’s merit cut-off. Rather, the grants went predominantly to sporting organisations in marginal electorates held by the Coalition.

When announcing tax cuts, Liberal politicians in particular love making speeches about how they’re only returning taxpayers’ own money. But in their attitude to pork-barrelling – it’s not illegal and everybody does it, in the immortal words of Saint Gladys – pollies on both sides act as though it’s really their money, to be spent as best suits their interests.

We’d know much less about their misuse of our money were it not for our auditors-general. The pollies want to keep it dark, but they can’t stop the auditors doing their duty. Scott Morrison was so grateful to the Australian National Audit Office he cut its funding. (More proof he regards taxpayers’ money as his own.)

As an accountant who was glad to escape auditing and become a journo, I’m pleased to acknowledge our debt to the auditors-general’s diligence. But I’m particularly impressed by the fearless Crawford’s blow against that great blight on budget honesty, “creative accounting” – using loopholes in the rules of public accounting to make the budget balance look better – or less worse – than it really is.

Some years ago, some bureaucrat in the NSW government (I doubt if any pollie could have come up with it) got the bright idea of making the budget look better by transferring the state’s railway assets to a new off-budget body, the Transport Asset Holding Entity.

This way, the cost of additional annual spending on rail infrastructure could be removed from the budget and treated “below the line” as an equity investment in a government-owned business. But this turned into an almighty and long-running battle between the state Treasury and the state Transport department.

Treasury prevailed and the Transport boss was dismissed without explanation. Enter the Auditor-General. Crawford declined to issue an audit report for the government’s 2020-21 accounts until she was satisfied all was in order.

In particular, she required evidence that the new holding entity was genuinely independent of the government and a genuinely profitable business. This would require higher annual payments from the budget for the use of the rail assets, thus reversing the engineered improvement.

Treasury delivered that evidence on December 23, allowing Crawford to issue an unqualified audit report about three months’ late. Soon after, Treasury secretary Mike Pratt, a former banker, announced his return to the private sector.

In another report last week, Crawford accused Treasury of obstructing her investigation into the holding entity by dragging its feet, withholding critical documents and overestimating the expected budget benefit from the transaction.

NSW Treasury’s reputation for probity has been damaged by evidence about the imbroglio given to a long-running parliamentary inquiry. Treasury regularly struggles to extract full and timely information from other departments. Now it has given them a master class in misbehaviour.

The parliamentary inquiry’s hearings have also damaged the reputation of KPMG – one of the big-four auditing firms moving into the more lucrative field of consultancy – which was revealed to have given opposing advice to Treasury on one side and Transport on the other.

The new NSW Treasury secretary is the highly experienced state and federal econocrat Dr Paul Grimes. Grimes has the distinction of having been sacked as head of the federal Agriculture department by Barnaby Joyce.

Joyce claims to have sacked him to show who was boss. It’s easier to believe that “a relationship of strong mutual confidence” between them wasn’t possible. In any case, the era of NSW Treasury being run by itinerant bankers seems to be over.

The holding-entity budget fiddle has its parallel federally. Both sides of politics have exploited a loophole in the definition of the budget balance introduced by Peter Costello’s Charter of Budget Honesty in the late 1990s.

The former Labor government used the loophole to stop its massive spending on the National Broadband Network from worsening the budget deficit by treating it “below the line” as an equity investment in a new for-profit business.

The present government is using the same trick to hide spending on its Nationals-inspired inland freight railway from Melbourne to Brisbane. A profitable business to be sold off at some future date? I think not.

There was a time when Yes, Minister was a reasonably accurate depiction of the relationship between a minister and his department head. But that was in Bob Menzies’ day. These days, the term “permanent head” is hardly apposite. Department heads have renewable fixed-term contracts, but it’s relatively common for prime ministers and premiers to lop off the heads of those who displease them.

When Tony Abbott sacked several department heads on coming to office in 2013, he was following the precedent set by John Howard in 1996. If the objective was to discourage unwelcome advice from bureaucrats – “Sorry, minister, that would be contrary to the Act” – it seems to have worked a treat.

So, how come our auditors-general are still so diligent in telling us when ministers have been playing ducks and drakes? Auditors-general are statutory officers appointed by the governor or governor general, and report to the parliament, not cabinet. They’re appointed for non-renewable eight or 10-year terms, and can’t move on to another government job. It’s a terminal appointment.
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Sense about improving education, before the political bulldust flies

In the looming election campaign we’ll be hearing a lot of silly, scary and self-serving stuff. Who’s better on the ukulele, ScoMo or Albo? Who’s the more “human”? Which side “won the week”?

We’ll see the content of carefully compiled “dirt files”. Each side accusing the other of hypocrisy. The other side’s policies have been/would be absolutely frightening.

Great. I can’t wait. But last week I ran across the thoughts of someone who’s had much experience in governance, but isn’t running for office. He was on about education – a topic of direct or indirect relevance to us all – but one that won’t be heard once all the shouting starts.

He’s Professor Peter Shergold, former head of the Prime Minister’s Department under John Howard, but these days chancellor of the University of Western Sydney and writer of government reports.

At every level of education – early childhood education and care, schools, universities and vocational education and training – the polite judgement on our performance is: could do better.

Shergold had many sensible things to say in a report to federal and state education ministers that lobbed only after the plague had begun.

He starts by putting education in a broader, more balanced context. “Education must prepare young people both for active citizenship in a democratic society and for purposeful engagement with the labour force,” he writes.

“This is vital at a time when trust in democratic governance and institutions is at a low level and cognitive technologies are transforming the future of work.”

School leavers don’t just need to be employable. They need to be adaptable, flexible and confident. Education must provide students with the essential attributes they require for lifelong learning in whatever fields of endeavour they may choose, he says.

The professional and applied skills they need will change significantly over their lives. The jobs they do will be transformed. Most will switch careers.

Academic achievement is important but not the sole reason for schooling. We need to focus more on preparing the whole person, no matter what career path they choose. Many senior secondary students enjoy school. Some, for a variety of reasons, just want to leave as soon as possible. Both groups need to be supported by more flexible learning.

Education will remain the foundation of a “fair go” Australia, Shergold says. Senior secondary students from disadvantaged backgrounds should be supported to ensure they can follow the same pathways available to others.

Literacy, numeracy and digital literacy should be recognised as essential skills for every student. At a time of technological transformation, when the future of work is uncertain, these attributes are more important than ever, he says.

Students must be supported to attain capabilities in these areas before they finish school. “Every young person who leaves school without them is having their economic and social future short-changed.”

All pathways through school should be delivered to the same high standard. While university will remain an aspiration for many young people, academic pathways should no longer enjoy more privileged access to school resources than apprenticeships, traineeships or other vocational education and training.

Shergold gets more specific in a report he wrote for the NSW Education Department with someone whose name seems familiar, a David Gonski. They find that vocational education and training – VET – is plagued by problems across the nation.

Skills development hasn’t received the level of government investment required, which has helped reinforce the public perception that VET is less valuable than university education. This misconception is too often instilled in students while they’re still at school.

When they move on from high school, they enter a world bifurcated between university and vocational education. Forced to choose, many opt for a uni degree, for which there are no upfront costs, rather than paying fees for certificate-level vocational education.

Partly because career advice is so poor, many parents and students believe the demand for vocationally qualified workers is in decline. This is utterly mistaken, Shergold and Gonski say.

Federal figures on skilled occupations show shortages in many trades, including mechanics, panel beaters, plumbers, electricians, bricklayers, plasterers, carpenters and cabinet-makers. A rapid rise in demand is forecast for certificate-trained workers in child care, aged care and disability care.

Get this: a “significant proportion” of uni graduates then move to VET to enhance their employability. It’s clear to me that a lot of kids who struggle through uni (with many failing to make it) would have been better going to VET.

Little wonder Shergold and Gonski want to bring universities and VET into a single system. They want much better career advice, which should be available to people throughout their working lives, including those obliged to make mid-career changes.

They want senior secondary schooling to be less obsessed with having kids direct all their efforts to maximising a single number, the Australian Tertiary Admission Rank. There are better ways for unis to select good recruits. And high schools could do more to get students started on a vocational “pathway”.

All this is worth debating in the coming weeks – but ain’t likely to be.

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The climate-change changes the politicians don't want to talk about

It’s strange to think that both sides of politics are leading us to a policy-free federal election campaign at a time when we have so many problems we should be debating. Not that the parties won’t have policies written on a bit of paper somewhere, but that they don’t want to talk about them.

Why not? Because any policy you propose can be used by your opponent to spread scare stories about your intentions. Last time, for instance, Scott Morrison used Labor’s support for electric vehicles to claim it was out to destroy the weekend.

This time, one issue neither side wants to dwell on is climate change. We have – at long last – reached bipartisan agreement on getting carbon emissions down to net zero by 2050. And on the question of how far we should have got by 2030 (yes got, not gotten; you may have reverted to English as it was spoken when the Pilgrim Fathers left England in 1620, but I haven’t), the parties are offering a genuine choice between ambitious and unambitious.

But neither side wants to talk about how we’ll get to net zero. Which leaves us in debt to a top energy expert, Tony Wood, of the independent think tank the Grattan Institute, who does want to talk about it.

Wood and his team flesh out something we know: that the main strategy is to get as much as possible of the energy we need from electricity.

“Households and business will rely on low- or zero-emissions electricity more than ever as it replaces their current use of petrol and diesel for transport and gas for cooking and heating,” he says.

Thanks to the move to renewables, emissions from the electricity sector have fallen consistently over the past five years and are expected to fall much further over this decade. But, on present policies, emissions from all other sectors – including transport, industry and agriculture – are expected to stay much the same.

To achieve net zero by 2050, demand for electricity is likely to double, at least. That means installing a lot more wind and solar (including rooftop) to meet this increased demand and to replace existing coal and gas-fired power stations as they’re retired.

As the anti-renewables crowd continually reminds us, this requires much ingenuity, effort and expense to ensure a reliable supply of power across the national electricity grid, despite the ups and downs of demand and the vagaries of wind and sun.

But it also involves a lot of investment in changing the transmission grid from one that largely moved high-voltage electricity from a handful of big power stations in the country to the big cities, to one that joins up a multitude of small commercial and household sources of solar and wind power. An increasing proportion of homes will be putting power into the grid sometimes and taking it out other times.

The Morrison government is insisting on a large and continuing role for natural gas in the electricity system. Wood is far from convinced. “The large-scale use of gas as a ‘transition fuel’ – supplying ‘base-load power’ with lower emissions than coal – does not stack up economically or environmentally,” he says.

Nearly 80 per cent of Australia’s hugely increased gas production is exported as liquefied natural gas. It’s sold at the world price, meaning “the good old days of low-priced east-coast gas are gone, making gas an increasingly expensive energy source”.

At present, gas provides about a quarter of Australia’s local energy consumption and contributes close to 20 per cent of our emissions. And whereas electricity prices have been falling, gas prices have been rising.

Gas has been declining as a share of Australia’s power supply since 2014, and this is likely to continue. “Gas will play an important backstop role in power generation when the sun isn’t shining and the wind isn’t blowing – but this role will not require large volumes of gas.”

In the home, people value being able to choose between gas and electricity for cooking and heating, but this can’t continue. They’ll save money and reduce emissions when all new houses are all-electric.

“The uncomfortable truth is that natural gas is most likely in decline in Australia, and achieving the net-zero target requires that to happen … Attempts to hold back the tide through direct market interventions, such as contemplated in [Morrison’s] National Gas Infrastructure Plan, will probably require ongoing subsidies at great expense to taxpayers.”

As for cars and other light vehicles, achieving net zero by 2050 requires all new cars to be electric or hydrogen-powered by 2035. That’s because, on average, our cars stay on the road for more than 15 years. The alternative is “costly and inefficient measures to scrap large numbers of cars in the 2030s and ’40s.”

To achieve the 2035 target, we need to do what almost every other rich country does. We need to do what the car manufacturers have asked for: set mandatory emissions standards. But neither major party is willing.

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Monday, February 28, 2022

Everyone else has an inflation problem, why can't we have one too?

I suspect we’re engaged in a strange exercise of trying to convince ourselves that we, like the Americans, Brits and Europeans, have a big problem with inflation. I fear that, if we try hard enough, we’ll succeed.

As the December quarter consumer price index shows, it’s true some prices have risen noticeably. The price of petrol has jumped and so have home building costs.

But, as our top econocrats have been reminding us, that’s not a big deal. The world price of oil has always gone up and down, for many reasons – none of which we have any ability to influence. Most other rises we’ve seen are temporary problems caused by the pandemic and governments’ response to it, as the supply of certain goods (but not services) falls short of demand. Computer chips, for instance.

And, as Reserve Bank governor Dr Philip Lowe demonstrated in his recent testimony to a parliamentary committee, our price rises are nothing like as big a deal as those in America, Britain and Europe, where there’s a lot more going on than just the passing effects of the pandemic.

Lowe noted that, over the past year, electricity and gas prices have risen by 25 per cent in the US and Europe, and even more in Britain, but by 2 per cent in Australia. Used car prices are up 40 per cent in the US, but nothing like that here.

People complain about rising rents but, as with mortgage interest rates, there’s a gap between advertised rates and what people actually pay. Actual rents have fallen in Sydney and Melbourne. And though everyone’s highly conscious of the jump in petrol prices, petrol accounts for only about 3 per cent of the cost of all the goods and services households buy.

The funny thing is, there are various groups in Australia that want to believe our problem’s as big as the other rich countries’. The key group is the financial markets. As Lowe said, “some in financial markets look at what’s going on in the United States and Europe and say, ‘They’ve got higher inflation, it’s coming to Australia’. They may be right” - he said before going on to explain why that was unlikely.

But so convinced are our financial markets that we’re just a carbon copy of the US economy that they’re laying bets the Reserve will be forced to start whacking up interest rates within a few months and will go hell for leather for the rest of the year.

The media have been happy to report this speculation as though it’s pretty much set in stone. “Inflation on the rise” is a good story and “rates to rise” even better.

As for the public, it’s kinda pleased to be told inflation’s a big problem, not because it likes rising prices, but because it confirms what people have always believed: that keeping up with “the cost of living” is always a struggle.

If you run a bit short before pay day, this is incontrovertible proof that prices are rising rapidly. The notion that the problem may be inadequate pay rises never seems to occur.

The CPI people carry in their heads always gets much bigger increases that the one calculated by the Bureau of Statistics because ordinary mortals’ memory of price rises is always stronger than their memory of price falls. And it never occurs to them to include in their sums all the many prices that didn’t change.

Which means, I fear, there’s a big risk that all the talk of inflation and rising prices – and all the media stories of a rise in this or that price; stories that multiply when “inflation” becomes the flavour of the month - could become a self-fulfilling prophecy.

To see this, you need to remember where we’ve come from: eight years of surprisingly weak growth in wages and six years of the (officially-calculated) inflation rate being below 2 per cent.

For much of that time, Lowe – whose scrutiny of statistics is supplemented by having his “liaison” people speak to more than 100 key businesses a month – has explained the weakness in wage and price inflation as arising from a strong “cost-control mentality” among Australian businesses.

Lowe explains that many businesses – retailing in particular – have been through a period of intense competition. There’s the threat from “category killers” such as Bunnings and Officeworks, the decline of department stores, Aldi taking on Coles and Woolies, and the move to online shopping, which has opened access to overseas competitors and made price more “salient” in decisions to buy things.

This increased competition came at a time when retail demand hasn’t been particularly strong (thanks mainly to weak wage growth). Special sales and other forms of discounting have been widespread.

In these circumstances, firms have been most reluctant to raise prices. Rises in purchase costs that may not last have been absorbed rather than passed on. Instead, firms have become obsessed with controlling their costs – including, and in particular, their labour costs.

In their book Radical Uncertainty, British economists John Kay and Mervyn King argue there’s no such thing as a profit-maximising firm. It’s not that firms wouldn’t like to earn maximum profits, it’s that they don’t know where that point is.

In real life, there’s no diagram or equation you can look up to tell you. You know there is a “price point” beyond which you’ll lose more in sales than you gain from the price increase, but you don’t know where it is. In real life, you have to feel your way, reading the signs and making sure you don’t push it too hard.

See where I’m going? We’re coming from a period where price rises have been heavily constrained for a long time. Not big, not many. “I haven’t been game to raise my prices because none of my competitors have been been either.”

Suddenly, however, everyone’s talking about inflation and every day the media are reporting that this price is rising and that price is going up. It’s obvious prices everywhere are taking off.

“One of my competitors has moved, so I can too. There’s always some cost increase I can point to. In this environment, I won’t get much push-back from customers. The media’s been softening them up.”

Can we talk ourselves into having a real inflation problem like the other rich countries? We’ll find out whether prices can be raised by imagination alone.

I fear, however, that getting those higher prices passed through to bigger wage rises will be a taller order. And, if that doesn’t happen, we’ll get no ongoing increase in the inflation rate, just a worsening in the cost of living.

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