Inflation is too tricky to be left to the Reserve Bank

The higher the world’s central banks lift interest rates, and the more they risk pushing us into recession, the more our smarter economists are thinking there has to be a better way to control inflation.

Unsurprisingly, one of the first Australian economists to start thinking this way is our most visionary economist, Professor Ross Garnaut. He expressed his concerns in his book Reset, published in early 2021.

Then, just before last year’s job summit, he gave a little-noticed lecture, “The Economic Consequences of Mr Lowe” – a play on a famous essay by Keynes, “The Economic Consequences of Mr Churchill”.

Academic economists are rewarded by their peers for thinking orthodox thoughts, and have trouble getting unorthodox thoughts published. Trick is, it’s the people who successfully challenge the old orthodoxy who establish the new orthodoxy and become famous. John Maynard Keynes, for instance.

In his lecture, Garnaut praised the Australian econocrats who, in the late 1940s, supervised the “postwar reconstruction”. They articulated “an inclusive vision of a prosperous and fair society, in which equitable distribution [of income] was a centrally important objective”.

The then econocrats’ vision “was based on sound economic analysis, prepared to break the boundaries of orthodoxy if an alternative path was shown to be better”.

It culminated in the then-radical White Paper on full employment, of 1945, under which policy the rate of unemployment stayed below 2 per cent until the early 1970s.

Garnaut’s earlier criticism of the Reserve was its unwillingness to keep the economy growing strongly to see how far unemployment could fall before this led to rising inflation. “We haven’t reached full employment [because] the Reserve Bank gave up on full employment before we got there.”

Now, Garnaut’s worry is that “monetary orthodoxy could lead us to rising unemployment without good purpose”.

“Monetary orthodoxy as it has developed in the 21st century leads to a knee-jerk tendency towards increased interest rates when the rate of inflation... rises.

“I have been worried about the rigidity of the new monetary orthodoxy since the early days of the China resources boom.” He had “expressed concern that an inflation standard was replacing the gold standard as a source of rigidity in monetary policy”.

Ah. That’s where his allusion to Churchill comes in. In 1925, when he was Britain’s chancellor of the exchequer, Churchill made “the worst-ever error of British monetary policy” by following conventional advice to suppress the inflationary consequences of Britain’s massive spending on World War I by returning sterling to the “gold standard” (Google it) at its prewar parity.

The consequence was to plunge Britain into deep depression years before the Great Depression arrived.

“If we continue to tighten monetary policy – raise interest rates – because inflation is higher that the target range, then we will diminish demand... in ways that seriously disrupt the economy.

“High inflation is undesirable, and it is important to avoid entrenched high inflation. But not all inflation is entrenched at high levels. And inflation is not the only undesirable economic condition.

“There is a danger that we will replace continuing improvement to full employment with rising unemployment – perhaps sustained unnecessarily high unemployment.

“That would be a dreadful mistake. A mistake to be avoided with thoughtful policy.”

Such as? Garnaut has two big alternative ways of reducing inflation.

First, whereas in the early 1990s there was a case for independence of the Reserve Bank because, with high inflation entrenched, it needed to do some very hard things, he said, “what we now need is an independent authority looking at overall demand, and not just monetary policy.

“We need an independent body playing a role in both fiscal and monetary policy... It would be able to raise or lower overall tax rates in response to the macroeconomic situation.”

Second, we shouldn’t be using higher interest rates to respond to the surge in electricity and gas prices caused by the invasion of Ukraine.

Because of the way we’ve set up our energy markets, the increases in international prices came directly back into Australian prices. This put us in the paradoxical position of being the world’s biggest exporter of liquified natural gas and coal, taken together, but most Australians became poorer when gas and coal prices increased.

“Many Australians find this difficult to understand. If they understand it, they find it difficult to accept.

“Actually, it’s reasonable for them to find it unacceptable,” he said.

So, what to do? We must “insulate the Australian standard of living from those very large increases in coal, gas and therefore electricity”.

How? One way is to cause domestic energy prices to be lower than world prices. The other is to leave prices as they are, but tax the “windfall profits” to Australian producers caused by the war, then use those profits to make payments to Australian households – and, where appropriate, businesses – to insulate them from this price increase.

By causing actual prices to be lower, the first way leaves the Reserve less tempted to keep raising interest rates. Which, in turn, should avoid some unnecessary increase in unemployment.

There are two ways to keep domestic prices lower than world (and export) prices. One is to limit exports of gas and coal to the extent needed to stop domestic prices rising above what they were before the invasion.

The other way is to put an export levy (tax) on coal and gas, set to absorb the war-cause price increase.

Either of these methods could work, Garnaut said. Western Australia’s “domestic reservation requirement” specifying the amount of gas exporters must supply to the local WA market, has worked well – but this would be hard to do for coal.

This week Treasury secretary Dr Steven Kennedy said the measures the government actually decided on could reduce the inflation rate by three-quarters of a percentage point over this year.

Garnaut’s point is that we’ll end up with less unemployment if we don’t continue leaving the whole responsibility for inflation to an institution whose only tool is to wack up interest rates.

Read more >>

It's no wonder the young hate Boomers like me

As I get older, more parts of my body are giving me gyp and I spend more of my life seeing doctors, but the people I don’t envy are the young. They may be fit and keen, but everywhere they look they see problems.

The big advantage of capitalism is supposed to be that it makes each generation better off than the last. But that’s breaking down before our eyes. The really harmful problem we’re leaving them is climate change, of course, but there’s much more than that.

They’re better educated than ever but, for many, it doesn’t seem to get them a secure, decently paid job. Even so, they leave education owing big debts to the government.

But, coming well behind climate change, the biggest disservice the older generation has done to them is to let the price of a home keep reaching for the sky.

We’re now at the point where each successive age group contains an ever-lower proportion of people who’ve managed to buy the home they live in.

In contrast, the aged have never had it better. The only thing they have to fear – and the young have to look forward to – is still needing to rent privately in retirement.

We’ve turned housing into Lotto. If you manage to win, they shower you in wealth. If you don’t win, you get screwed. Renters have few rights because, as we all know, it’s just a temporary state for the young.

And then the Baby Boomers (like me) wonder why the young seem to hate them. It’s not true that all Baby Boomers are rolling in it. Some of them don’t even own their own home. But most of them (like me) were able to buy early in their lives, when first homes were affordable. Since then, they’ve just sat back in delighted amazement as their wealth has multiplied.

Of course, if there’s anything wrong with the way the world’s run, it wasn’t anything I did, it was those terrible pollies. Yeah, nah.

Since older home owners have always far out-numbered the young would-be home owners, the politicians have always run the housing game to favour those who love seeing property prices rise – and, now you mention it, wouldn’t mind buying another house as an investment.

At present, it’s easy to conclude the big problem with housing affordability is rising interest rates and so blame it all on the Reserve Bank boss Dr Philip Lowe. But, as I’ve written elsewhere, although it’s reasonable to ask whether putting interest rates up and down is a sensible and fair way to manage the economy, that’s a separate issue.

Home loans take two to tango: how much you have to borrow and the interest rate on the loan. The interest rate cycles up and down around a relatively stable average, whereas the amount you need to borrow has gone up and up, decade after decade.

True, house prices are falling at present, but this is just returning them to where they were before they took off during the pandemic. It’s a safe bet that, once they’ve finished falling, they’ll resume their upward climb.

This is why oldies are wrong to scoff at young people complaining about mortgage interest rates of 5 per cent. “In my day, I had to pay 17 per cent!” Yes, you did – for a year or so in the early 1990s, when the amount you had to borrow was much less.

What’s true is that, right now, it’s mainly younger people who borrowed huge sums in the past few years who’re really feeling the pain.

But the real question is why house prices have risen so far for so long. They’ve risen much faster than incomes. The Grattan Institute calculates that whereas typical house prices used to be about four times incomes, now they’re more than eight times – and even more in Melbourne and Sydney.

But why? Not because of anything the Reserve Bank has done. Nor so much because we’ve failed to build enough additional houses and units to accommodate the growth in the population.

More because our tax and social security rules have made home ownership a highly attractive, government-favoured form of investment, not just a place you can call your own and not be chucked out of as long you keep up the payments. People who buy investment properties out-compete would-be first home owners, bidding up the price.

But also because there’s more competition to buy homes in particularly desirable areas. Spots near the beach or the river, for instance, but also places near where the jobs are.

People have been crowding into the big cities, trying to get close to the CBD with all its well-paid office jobs, but the older home owners fight hard to discourage governments from making room for younger newcomers. “It’s so ugly.”

And the bank of mum and dad (yes, I’ve done it) is helping prices stay high, while widening the divide between those young people with well-placed parents and those without.

Read more >>

Interest rates: Lowe's not the problem, the system is rotten

When interest rates seem likely to be raised more than they need to be, it’s only human to blame the bloke with his hand on the lever, Reserve Bank governor Dr Philip Lowe. But it’s delusional to imagine that fixing the problem with “monetary policy” is simply a matter of finding a better person to run it.

This assumes there’s nothing wrong with the policy of using the manipulation of mortgage interest rates as your main way of managing the economy and keeping inflation low and employment high. In truth, there’s a lot wrong with it.

It ought to be a happy coincidence that, just as our central bank is making heavy weather of its first big inflation problem in decades, the Albanese government had already commissioned a review of its performance.

Treasurer Jim Chalmers will receive its report late next month. But particularly because the review is headed by an overseas central banker, it’s likely to recommend relatively minor changes to the way the Reserve performs its present role – changing the composition of its board, for instance – rather than answer a more fundamental question: can’t we find a better way to manage the macroeconomy than relying so heavily on dicking around with interest rates?

It’s a pity you have to be as ancient me to know there’s nothing God-ordained about the notion that central banks must have primary responsibility for stabilising the economy, with the elected government’s “fiscal policy” (the manipulation of government spending and taxes) playing a subsidiary role, and the central bankers being independent of the elected government.

This arrangement became the conventional wisdom only in the mid-1980s, after many decades of relying mainly on using the budget, with monetary policy’s job being to keep interest rates permanently low.

The fact is that, as instruments for managing demand, monetary policy and fiscal policy have differing strengths and weaknesses. The switch from fiscal to monetary primacy seemed to make sense at the time, and to hold the promise of much more effective stabilisation of the economy as it moved through the ups and downs of the business cycle.

Then, we were very aware of the limitations of fiscal policy. But after 40 years, the limitations of monetary policy have become apparent. For one thing, we learnt from the weak growth in the decade following the global financial crisis that monetary policy is not effective in stimulating growth when interest rates are already very low and households already loaded with debt.

Now we have high inflation caused primarily by problems on the supply (production) side of the economy. Can monetary policy do anything to fix supply problems? No. All it can do is keep raising interest rates until the demand for goods and services falls back to fit with inadequate supply.

But as a tool for limiting demand, monetary policy turns out to be primitive, blunt and unfair. Its manipulation of interest rates has little effect on borrowing for business investment, and little direct effect on all consumer spending except spending on mortgaged or rented housing.

In practice, this means monetary policy relies on manipulating the housing market to influence consumer spending indirectly. When you want to encourage demand, you cut mortgage interest rates to rev up the housing market. When you want to discourage demand, you raise rates to smash the housing market.

Putting up mortgage interest rates discourages people from buying housing – including newly built homes, which hits the home-building industry directly. But by increasing mortgage payments and rents, it hits consumer spending indirectly, by leaving households with less to spend on other things.

See how round-about monetary policy is in achieving its objective? It hits some people hard, but others not at all. As a reader wrote to me: “It just doesn’t make sense to me that one segment of the population is going through financial pain and suffering when others aren’t affected. Surely, there are [other] ways the government or Reserve Bank can bring inflation under control?”

Good point. Why does stabilising the economy have to be done in such a round-about and inequitable manner? As other readers would tell me, why do older people dependent on interest income have to take a hit whenever the Reserve decides to encourage borrowing and spending by cutting interest rates?

Truth is, central banks can’t afford to worry about whether dicking around with interest rates is fair or unfair: it’s the only tool they’ve got. To someone with a hammer, every problem is a nail.

And although economists have forgotten it, there are other, less round-about and less unfair ways to discourage or encourage consumer spending. In the olden days, governments added a temporary surcharge or discount to the income tax scale.

These days, you could do the same to the rate of the goods and services tax. If you didn’t trust the pollies to do it, you could give the power to an independent commission.

The Reserve rightly asserts that many of the price rises we’ve seen can’t be explained by supply problems, but must be attributed to excessive demand, caused by all the stimulus unleashed during the pandemic.

It fits the monetary policy-primacy mindset to blame this on excessive fiscal stimulus via all the temporary government spending and tax breaks. But a much better case can be made that the excess came from monetary policy.

Indeed, the response to the pandemic may have been far less inflationary than it proved to be had the Reserve left it all to fiscal policy. Since, with the official interest rate already down to 0.75 per cent, it was already almost out of ammunition, I expected the Reserve to sit it out and leave the heavy lifting to fiscal policy.

But no, like the other rich-country central banks, the Reserve leapt in. And, not content with cutting the official rate to 0.1 per cent, it resorted to various unconventional measures, lending to the banks at discount rates and buying several hundred billions-worth of government bonds to lower also multi-year housing fixed interest rates.

While the Reserve was doing this, both federal and state governments were offering people special concessions to buy newly built homes. The combined effect was to give the housing industry a humungous boost. House prices soared, as did the cost of a new home once the supply of building materials and labour ran out.

Guess what? If you take the part of our rise in consumer prices that can’t be attributed to supply problems and imported inflation, you find much of it’s explained by the cost of building a new home, which rose by an amazing 27 per cent over the 18 months to December.

It’s reasonable to believe that our inflation wouldn’t be nearly as bad, had the Reserve left the coronacession to fiscal policy, as it should have. Why didn’t it? Because it, like the other rich-country central banks, now thinks it owns macroeconomic management.

It just had to be out there, pushing the treasurer and Treasury away from the microphone and showing it was in charge – while it made matters worse. This is the central banking problem we - and the other rich countries - should be grappling with.

Read more >>

Globalisation has stopped, but it's not actually reversing - yet

In case you’ve been too worried about your mortgage to notice, the era of ever-increasing globalisation has ended. There’s a backlash against greater economic integration and a risk it will start going backwards, causing the global economy to “fragment”.

The process of globalisation involves the free flow of ideas, people, goods, services and financial capital across national borders, leading to economic integration. But, as a new post on the International Monetary Fund’s blog site reminds us, globalisation is not new, and the process has ebbed and flowed over many decades.

The post charts the progress of globalisation back more than 150 years. Using openness to international trade – measured as global exports plus imports as a proportion of world gross domestic product – it divides that period into five successive eras.

First came the era of industrialisation between 1870 and 1914, when increasing trade between Europe and the “new world” of North America, Argentina and Australia was driven largely by technological advances in transportation – including steel-hulled, steam-driven ships and refrigeration for shipping meat – which lowered the cost of trade.

The laying of undersea cables to improve communication between countries also helped.

Then came the era of wars and protectionism, beginning with the start of World War I in 1914 and finishing with the end of World War II in 1945.

In between came the Great Depression of the 1930s, which was made much worse than it needed to have been by governments trying to protect their domestic industries by using high import duties (“tariffs”) to keep people buying local.

It sounds like a great idea when you do it to other countries. It turns into a stupid idea when they retaliate and do it to you, leaving everyone worse off.

After trade had increased from 30 per cent of world GDP to more than 40 per cent during the era of industrialisation, it had fallen back to about 15 per cent by the end of World War II.

Third came the era of tariff reform between 1945 and 1980. Even before the war had ended, the Allies knew they’d have to fix the world economy. They decided to move to a system of fixed exchange rates and establish the IMF and the World Bank. Most importantly, they set up the General Agreement on Tariffs and Trade (now the World Trade Organisation).

The GATT arranged eight successive “rounds” of multilateral trade negotiations, in which the developed countries agreed to big reductions in their barriers to imports. Thanks to all this, trade doubled from 15 per cent of world GDP to 30 per cent.

This led on to the era of “hyperglobalisation” between 1980 and 2008, with the fall of the Berlin Wall in 1989 and collapse of the Soviet Union, bringing the Cold War to an end.

The eighth, biggest and final, “Uruguay” round of the GATT, in 1994, focused on increasing trade between the developed and developing countries, with many poor economies joining the WTO.

China’s economy began growing rapidly after it was opened up in the late 1970s, and in 2001 it was permitted to join the WTO, hugely increasing its trade.

The era also brought a move to floating exchange rates and deregulation of banking systems, leading to much increased investment between rich and poor countries.

As well, big advances in telecommunications, computerisation and the advent of the internet allowed a surge of trade in digital services, including data processing.

Resulting from all this, trade reached a peak of more than 55 per cent of world GDP in 2008, on the eve of the global financial crisis and the ensuing Great Recession.

The IMF bloggers label the present period, with figures from 2008 up to 2021, the era of “slowbalisation”. To date, those figures bear this out: trade has reached a plateau of about 55 per cent. More recent figures show world trade has largely bounced back from the initial effects of the pandemic’s global coronacession.

It seems the combined effect of the Great Recession and rising protectionist sentiment has stopped trade from continuing to shoot up relative to world GDP, but not caused it to fall back – or not yet.

Less optimistic observers, however, refer to present as the era of “deglobalisation”. They worry that we’re in the early stages of a period of “policy-induced geoeconomic fragmentation”.

It’s not hard to see what’s worrying them. First we had Britain deciding to leave the European Union, then the election of Donald Trump, vowing to “make America great again” by whacking up tariff barriers against the exports of friend and foe alike, and starting a trade war with China.

Now we have the use of trade and other economic sanctions by many countries to punish Russia in its war against Ukraine, which is fragmenting world trade.

US President Joe Biden has toned down his predecessor’s excesses, but not abandoned the trade war. This doesn’t seem to be about protectionism so much as America’s desire not to be overtaken by China as the world’s dominant superpower. In particular, the US wants to stay ahead of the Chinese in advanced digital technology, by denying them access to the latest and best semiconductors.

The risk is that the two could end up dividing the global economy into separate trading blocs, America and its democratic friends versus China and its autocratic friends. This would almost certainly slow the economic growth of both groupings.

And, as economist Dr John Edwards has written, dividing the trading world into good guys and bad guys would not suit us, nor our region. Our exports to China greatly exceed our exports to the US and other close security allies.

And all the East Asian economies – including Japan and South Korea – have China as a major trading partner. For that matter, China and the US are major trading partners of each other.

Fortunately, and despite all the sparring we’ve seen, Edwards and others find no evidence that the US and China have yet started to “decouple”.

Let’s hope economic sense prevails, and it stays that way.

Read more >>

If GPs want more money, they'll have to be less alergic to change

Who’d be Anthony Albanese? Everywhere he looks, another problem. Now it’s the GPs. They’ve become a lot harder to get to see, and more expensive. Even getting them to return your call can take days.

It’s become so bad even the premiers are complaining. What’s it got to do with them? When some people find it too hard or costly to see a GP, they take their problem to a public hospital’s emergency department, where waiting times are long, but there’s no charge.

Even the ambos are complaining that too many of their call-outs are to take someone with a minor problem to the emergency department.

The GP “crisis” was discussed at the national cabinet meeting on Friday, which received the final report of the Strengthening Medicare Taskforce. You can find the report on the internet but, although it’s mercifully short at 12 pages – with lots of lovely glossy photos of happy, good-looking Aussies, I doubt you’d find it very informative.

Remember the joke that a camel is a horse designed by a committee? The pictures suggest it’s intended for ordinary readers, but it’s written in bureaucratic code that would be crystal clear to any expert who already knew what it was saying.

You wade through guff about “access to equitable, affordable, person-centred primary care services” and “co-ordinated multidisciplinary teams” to find the odd bit you understand.

See if I do better. According to the doctors’ union, the AMA, the reason GPs have become so hard to find is that the federal government isn’t paying them enough. Whereas in the old days half of all medical graduates became GPs, now it’s down to about 15 per cent.

So, pay them more. Problem solved.

What the report’s saying is: sorry, not that simple. It’s true the Coalition government inherited a temporary freeze in Medicare rebates – the amount of a doctor’s bill that’s paid by the feds – in 2013, and continued it until 2018. And although the schedule of rebate payments has been increased annually since then, the increases have been much smaller than inflation.

Why? Partly because the Liberals were trying to prove they could cut taxes without damaging “essential services” such as Medicare.

But also because they knew something was wrong with the way general practice works. They needed to pay GPs differently to do different things. Rather than pay more and more the old way, they’d hold back until they – or some future government – worked up the courage to make changes.

Over the almost 40 years of Medicare, there’s been a big change in the problems people bring to their GPs. Because we’re living longer, healthier lives, much more of our problems are chronic – someone with heart trouble or diabetes has to wrestle with it for the rest of their lives – rather than acute: something that’s easily and quickly fixed.

But the present (subsidised) fee-for-service way of remunerating doctors is designed to suit acute problems, not chronic conditions. It involves waiting for problems to arise, not early diagnosis or stopping chronic conditions getting worse.

It encourages GPs to keep consultations short, avoiding long discussions of multiple problems.

A change no one wants to talk about is the way sole practitioners or partnerships of doctors are giving way to companies owning chains of practices staffed by doctors they employ.

When you separate the person delivering the care from the person watching the bottom line, you increase the likelihood doctors are pressured to keep consultations short and order many tests – a further reason to be cautious about reinforcing GPs’ dependence on fee-for-service.

The report wants to move to “blended” funding, with acute consultations continuing to be fee-for-service, but GPs paid lump sums for developing and managing “care plans” for particular patients with chronic conditions.

While it’s true fewer medical graduates are becoming GPs, it’s not the whole truth. As the Grattan Institute reveals, “Australia has more GPs per person than ever before, more GPs than most wealthy countries, and record numbers of GPs in training.”

How do other countries with good healthcare get by with fewer GPs? By making sure their GPs can’t insist on doing things that could be done by other health workers – nurses, nurse practitioners (nurses trained to do some of the more routine things doctors do), pharmacists and physios.

This is what “co-ordinated, multidisciplinary team-based care” means. Changing GPs’ surgeries into more wide-ranging “primary care clinics” is also about making it easier for patients to move between different kinds of care, with GPs taking more responsibility for the total package, and all the various doctors and paraprofessionals having access to a patient’s medical history.

There’s nothing new about this. Federal governments have been trying to improve the performance of primary care for decades – with little success. Why? Because they’ve had so little co-operation from the premiers and the GPs themselves.

The true message of the latest report is: Medicare reform must not just be about more money to do the same things the same way.

Read more >>

Want a better economy? Design better policies, don't just pick sides

A wise person has said that our brains love to make either-or choices. Which is why it’s wise not to waste much energy on the concocted furore over Treasurer Jim Chalmers’ 6000-word essay musing on future economic policy.

The world is a complicated place, and so are the choices we make about what we need to do get an economy that improves the lives of the humans who constitute it, including those at the bottom, not just the top.

But our brains look for ways to simplify the many choices we face. The simplest choice is binary: between A and B, black or white, good or bad. This fits with our tribal instincts. My tribe versus the rest, us and them, the good guys versus the bad guys.

Our two-party political system has been built to keep things simple. And thus, to minimise the need for hard thinking. Many people don’t have time to decide what they think about this policy or that, so they pick a political party and outsource their thinking to it.

“Am I for it or against it? Tell me what my party’s saying, and I’ll know what I think.” There’s plenty of survey evidence that people who voted for the government – any government – are more inclined to think the economy’s going well, whereas those who voted for the other side think it’s going badly.

Too much of the outrage over Chalmers and his essay has come from media outlets whose business plan is to pander to the prejudices of a particular “market segment”.

Economists like to think of themselves as rational and objective, but economics and economy policy are highly susceptible to binary choices, and fads and fashions.

All I’ve seen over the years has made me a believer in the pendulum theory of history: we tend to swing from one extreme to the other. After World War II, people – particularly in Britain and Europe - were very aware of the failings of the private sector, so they decided to nationalise many industries.

By the time Maggie Thatcher and Ronald Reagan arrived, people had become very aware of the failings of government-owned businesses. So they decided to privatise many industries.

The big binary issue in economic policy is broader than privatisation, it’s government intervention in markets. Should governments intervene as little as possible, or as much as is necessary? To put it in the comic book terms beloved by Chalmers’ partisan critics: we face a choice between the free market or socialism.

Except that we don’t. My point is that the truth – and the ideal place to be – is unlikely to be found at one extreme or the other. It’s much more likely be somewhere in the middle.

To me, this is what economics teaches. It’s why economists say we should make decisions “at the margin” and are obsessed by finding the best “trade-off” between our conflicting objectives.

We want to be free to do as we choose, but we also want to be protected from instability (high inflation and high unemployment) and unfair treatment in its many forms.

The period of deregulation and privatisation instigated by the Hawke-Keating government in the mid-1980s, known locally as “micro-economic reform” motivated by “economic rationalism”, eventually degenerated into a belief in public bad/private good under subsequent governments, and was dubbed “neoliberalism” by leftie academics.

While the inclination to favour business and sell off government businesses remained under the former Coalition federal government, it had no commitment to minimising government intervention. Its willingness to impose its wishes on electricity and gas producers, for instance, was often on display.

And while the big reforms undertaken in the name of economic rationalism – floating the dollar, deregulating the banks, ending import protection, and introducing national competition policy – have served us well, many of the privatisations and efforts to outsource provision of government services have not.

In 2023, we’re left somewhere between the two extremes, with an economy that’s not working nearly as well as we need it to. Chalmers and Labor’s other ministers will have to intervene – but do so in ways they’re reasonably sure will make matters better rather than worse.

That’s the hard part, and their econocrat advisers aren’t nearly as well-equipped as they should be to tell them “what works and what doesn’t”.

Why not? Because we’ve done far too little hard thinking about the problems, preferring to take refuge in the happy delusion that the answer lies at one extreme or the other.

Read more >>

Why the customer doesn't always come first

The world is a complicated place. I have no doubt that the capitalist, market-based way of running an economy delivers the best results for workers and consumers. But that doesn’t mean companies never do bad things, nor that every business always does the right thing by its customers.

The father of modern economics, Adam Smith, famously said that “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest”.

But, he argued, the “invisible hand” of “market forces” – the interaction of demand and supply in moving prices up and down – takes all the self-interest of businesses and the self-interest of consumers and turns them into businesses getting adequately rewarded for delivering just the right combination of goods and services to all the people in the economy.

There’s a huge amount of truth to that simple – if hard to believe – proposition. But it’s not the whole truth. One way to think of it is that, as Winston Churchill said of democracy, it’s the worst way of doing it – except for all the other ways. In this case, except for leaving all the decisions about what and how much to produce to the government.

So, to say capitalism is the best way of organising an economy isn’t to say it’s without fault. That it never does things badly.

In a speech this week, Rod Sims, the former chairman of the Australian Competition and Consumer Commission, but now a professor at the Australian National University, said that although companies regularly proclaim that they put their customers first, “companies clearly do not always have the interests of their customers in mind”.

So what are the reasons that, almost 250 years after Smith’s discovery, capitalism doesn’t always give consumers a good deal.

Sims can think of six reasons market forces don’t live up to their billing.

For a start, meeting customer needs may not be the main way companies increase their profits. Businesses are motivated to make profits and to increase those profits. But being the best at meeting the needs of customers isn’t the only way, or even the dominant way, firms succeed, Sims says.

For a firm to stay ahead of its rivals by continually improving its products and services is difficult. And eventually another firm works out how to do things better and cheaper than you.

“Commercial strategy therefore is largely about building defences against the forces of competition. To make it more difficult for other firms to develop a better product. Or, if they do, to limit their access to customers,” he says.

Another reason is that company executives are under considerable sharemarket pressure to increase short-term profits. Companies strive to grow because this attracts investors, the value of their shares rises and their top executives get bigger bonuses.

Sims says many companies set high growth targets to meet the expectations of the sharemarket. Often these targets are higher than the economy’s growth, meaning not all firms can meet or exceed market expectations.

So, in some cases, company executives see no alternative but to push the boundaries to achieve the targets they’ve been set.

That’s bad, but it becomes worse if the poor behaviour of a few causes normal competitive pressure to keep getting better than the others to reverse and become a race to the bottom.

Sims says that in well-functioning markets firms compete on their merits. Firms that offer what consumers value, displace firms that don’t. But the opposite can occur if poor behaviour goes undetected and unpunished, so it gives bad players a competitive edge.

“Firms can win customers through misrepresenting their offers and employing high-pressure selling tactics,” he says. As well as hurting consumers, such behaviour hurts rival firms, tempting them to protect their market share by employing the same questionable tactics.

Yet another problem occurs when firms see nothing wrong with what they’re doing, but their customers do. They (and economists) see nothing wrong with offering a better price – or interest rate – to new customers than they’re charging their existing customers.

But those older customers commonly react with outrage when they discover they’ve gone for years paying more than they needed to. They feel their loyalty has been abused.

Speaking of loyalty, Sims’ final explanation of why customers may be treated badly is that executives may feel their obligations to their company compel them to pursue profit to the maximum, even if their behaviour pushes too close to the boundaries of the law and isn’t the behaviour they would engage in privately.

So, what should be done about all these instances of “market failure” – where markets don’t deliver the wonderful benefits advertised by economists?

Sims has two remedies. First, as he argued strongly while boss of the competition and consumer commission, it needs stronger merger laws to help it prevent anti-competitive mergers. The courts require evidence about what will happen after a merger has occurred, but it’s hard for the commission to prove what hasn’t yet happened.

“The courts seem largely unwilling to accept commercial logic; that if you have market power you will use it. The courts can sometimes seem naive,” he says.

Second, we need a law against unfair practices, as they have in the United States, Britain and most of Europe.

“Our current laws are poorly suited to stopping behaviour ranging from online manipulation of consumers, to processors saying they will reject farm goods unless the prices agreed before the goods were shipped are now lowered.”

In the end, it’s simple. All the claims that capitalism will deliver a great deal for consumers are based on the assumption that businesses face stiff competition from other businesses to keep them in line.

But when too many markets are dominated by a few huge companies, service goes down and prices go up by more than they should.

Read more >>

Labor's new plan to reduce our emissions is riddled with loopholes

While I was on holiday, I noticed a tweet that left me in no doubt about the subject of my first column back. It said: “I genuinely think the next generation will not forgive us for what we have done to them and the world they will have to live in.”

I, too, fear they won’t. I don’t know whether our political leaders ever think such thoughts, but it fills me with dread. Maybe the pollies think what I reluctantly think: With any luck, I’ll be dead before the next generation realises the full extent of the hell our selfish short-sightedness has left them in.

But the climate seems to be deteriorating so rapidly I’m not sure I’ll get off that easily. I love my five grandkids, but I’m not looking forward to the day they’re old enough to quiz me on “what I did in the war”. What was I saying and doing while our leaders were going for decades kicking the problem down the road as the easiest way to get re-elected?

“Well, I was very busy writing about the shocking cost of living – oh, and rising interest rates.” Really? Is that the best excuse you can offer, Grandad?

We elected a bloke called Albo who promised to try a lot harder than his predecessors to reduce our emissions of greenhouse gases. He said he’d cut them by 43 per cent by 2030. He was quick to put that target into law, and his people worked through the Christmas holidays to outline the “safeguard mechanism” he’d use as his main measure to achieve the reduction.

While the rest of us were at the beach, Climate Change Minister Chris Bowen announced a few weeks ago that Australia’s 215 biggest industrial polluters – running coal mines, gas plants, smelters and steelworks – will have their emissions capped, with the caps lowered progressively by 30 per cent come 2030.

Businesses whose emissions exceed their cap will face heavy fines. To the extent they can’t use cleaner production processes to reduce their emissions, they’ll be allowed to buy “carbon credits” from other heavy polluters who’ve been able to reduce their emissions by more than required, or from farmers who’ve planted more trees.

Trouble is, it wasn’t long before the experts started pointing to all the holes in the scheme. For a start, the combined emissions of these biggest polluters account for only 28 per cent of Australia’s total emissions.

For another thing, the notion that, as well as reducing the carbon we’re adding to the atmosphere, we should find ways to remove some of the carbon that’s already there is a good one in principle, but riddled with practical problems.

Whereas the carbon we emit may stay in the atmosphere for 100 years or more, the carbon sequestered by a new tree will start returning to the atmosphere as soon as it dies or is cut down. It’s hard to measure the amount of carbon that tree-growing and other agricultural activities remove, which makes such schemes particularly easy to rort.

In his recent report into expert criticism of our carbon credits scheme, Professor Ian Chubb sat on the fence. While judging the scheme to be “well designed”, he identified various dubious practices that should be outlawed. And he stressed that big polluters must not rely on buying carbon credits to the extent that they’re able to avoid reducing their emissions in absolute terms.

A further weakness in the government’s scheme comes from its refusal to prohibit any new coal mines and gas plants, despite the International Energy Agency and other international agencies saying the world won’t have any chance of avoiding dangerous climate change if it’s relying on new gas or coal projects.

So, the scheme involves leaning on our existing 215 biggest polluters to reduce their emissions by 30 per cent, while allowing a bunch of new big emitters to set up, provided they then start cutting those emissions back.

Really? This is how we’re going to cut our total emissions by 2030? Seriously?

Last year a reader rebuked me for failing to make it clear that nothing Australia does to reduce its own emissions can, by itself, have any effect on our climate. Why not? Because climate is global, and we’re not big enough to have a significant effect on total world emissions.

The best we can do is set a good example, then pressure the bigger boys to do likewise. So far, we’ve been setting them a bad example.

It’s the global scale of the problem that makes our efforts actually to increase our exports of coal and gas so irresponsible – and, to our offspring, unforgivable. We’re the world’s third-largest exporter of fossil fuels, after Saudi Arabia and Russia.

Australia’s emissions within our borders are dwarfed by the emissions from the coal and gas we export. But never mind about that. Let’s just extract a few more shekels before the balloon goes up.

Read more >>

Never ask an economist to tell you a story

Tell me, are you planning to read any good books over the break? Maybe go to the movies? Certainly, watch a fair bit of streaming video? I bet you are. And I bet most of what you read or watch will be fiction.

If it’s non-fiction, it’s most likely to be a biography – the story of someone’s life.

How can I be so sure? Because, though it’s taken economists far longer than anyone else to realise – and many of them still haven’t read the memo – humans are a story-telling animal.

It’s something psychologists and other social scientists have long understood – although, being academics, they prefer to use the more high-sounding “narratives”.

Humans have been telling themselves stories since we lived in caves and sat around campfires. The eminent American biologist, E.O. Wilson, said storytelling was a fundamental human instinct. Evolution has wired our brains for storytelling.

Jonathan Gottschall, author of The Storytelling Animal, says we are, as a species, addicted to stories.

“Even when the body goes to sleep, the mind stays up all night telling itself stories,” he says.

You can say we like telling and listening to stories because we enjoy them and find them entertaining. Sure. But why has our evolution programmed us to enjoy stories so much?

Because stories add to our “fitness” to survive and prosper as a species. Because stories are the way humans make meaning out of the seeming chaos of life.

Gottschall says storytelling “allows us to experience our lives as coherent, orderly and meaningful”. Another author, Peter Guber, says stories have helped us share information long before we had a written language.

We turn facts we want to remember into stories, and we remember facts embedded in stories better than facts that aren’t.

Stories engage our emotions, not just our intellect, which is what makes them so powerful. We don’t remember much of the key figures and facts summarising the seriousness of the latest famine in Africa, but we do remember the story about a little girl, all skin and bones.

So, what have stories got to do with economics, especially when economics is more about impersonal concepts than about particular people? More than many economists want to admit.

Just as stories are our way of making meaning out of the seeming chaos of life, so the economists’ “models” – whether the ones they carry in their heads or the sets of equations they program into a computer – aren’t as scientific as economists like to think.

Models are an economist’s way of making sense of the seeming chaos of the economy, which makes them just another (less entertaining) form of story. As their name implies, models aren’t the economy, they’re just models of the economy, which don’t reproduce all the complexity of the actual economy.

Modellers select just a few of the economy’s moving parts – the ones they believe do most to drive the economy – and ignore the many hundreds of parts that usually don’t play a big part in moving the economy along.

Models that don’t simplify the story of how the economy works are of no use to anyone because they don’t reduce the seeming chaos.

All of which is true of the stories we tell each other of what motivates people to behave the way they do in particular circumstances, and of what are the main things that matter in our efforts to get rich or have a successful marriage or live a satisfying life. Like models, our stories cut to the chase.

Nobel laureate Robert Shiller, a pioneering behavioural economist, was among the first to explain “how stories go viral and drive major economic events” in his book, Narrative Economics.

He shows how simple economic stories, when widely believed, can shape economic policy decisions, as politicians and their advisers face pressure to act according to the public narrative.

Whether the results are good or bad depends on whether the narrative is true. His insights are particularly relevant to explaining financial crises, housing cycles and sharemarket bubbles.

If you haven’t decided what you think about globalisation and the latest push to roll it back, a good book to read is Six Faces of Globalisation, by Anthea Roberts, of the Australian National University, and Nicolas Lamp, of Queen’s University in Ontario.

One review says it’s not just a book about globalisation, but also “the power and importance of narrative: how it is constructed and how it can contribute to a far more nuanced and complex understanding of the forces of change”.

What the authors did is take all the conflicting arguments for and against globalisation and boil them down to six contesting “narratives”. Why? To make it easier for us to understand the debate and the differing perspectives.

Read more >>

RBA warning: our supply-side problems have only just begun

In one of his last speeches for the year, Reserve Bank governor Dr Philip Lowe has issued a sobering warning. Even when we’ve got on top of the present inflation outbreak, the disruptions to supply we’ve struggled with this year are likely to be a recurring problem in the years ahead.

Economists think of the economy as having two sides. The supply side refers to our production of goods and services, whereas the demand side refers to our spending on those goods and services, partly for investment in new production capacity, but mainly for consumption by households.

Lowe notes that, until inflation raised its ugly head, the world had enjoyed about three decades in which there were few major “shocks” (sudden big disruptions) to the continuing production and supply of goods and services.

When something happens that disrupts supply, so that it can’t keep up with demand, prices jump – as we’ve seen this year with disruptions caused by the pandemic and its lockdowns, and with Russia’s attack on Ukraine.

What changes occurred over the three decades were mainly favourable: they involved increased supply of manufactured goods, in particular, which put gentle downward pressure on prices.

This made life easier for the world’s central banks. With the supply side behaving itself, they were able to keep their economies growing fairly steadily by using interest rates to manage demand. Put rates up to restrain spending and inflation; put rates down to encourage spending and employment.

The central banks were looking good because the one tool they have for influencing the economy – interest rates – was good for managing demand. Trouble is – and as we saw this year – managing demand is the only thing central banks and their interest rates can do.

When prices jump because of disruptions to supply, there’s nothing they can do to fix those disruptions and get supply back to keeping up with demand. All they can do is strangle demand until prices come down.

So, what’s got Lowe worried is his realisation that a lot of the problems headed our way will be shocks to supply.

“Looking forward, the supply side looks more challenging than it has been for many years” and is likely to have a bigger effect on inflation, making it jump more often.

Lowe sees four factors leading to more supply shocks. The first is “the reversal of globalisation”.

Over recent decades, international trade increased significantly relative to the size of the global economy, he says.

Production became increasingly integrated across borders, and this lowered costs and made supply very flexible. Australia was among the major beneficiaries of this.

Now, however, international trade is no longer growing faster than the global economy. “Trading blocs are emerging and there is a step back from closer integration,” he says. “Unfortunately, today barriers to trade and investment are more likely to be increased than removed.”

This will inevitably affect both the rise in standards of living and the prices of goods and services in global markets.

The second factor affecting the supply side is demographics. Until relatively recently, the working-age population of the advanced economies was steadily increasing. This was also true for China and Eastern Europe – both of which were being integrated into the global economy.

And the participation of women in the paid labour force was also rising rapidly. “The result was a substantial increase in the number of workers engaged in the global economy, and advances in technology made it easier to tap into this global labour force,” Lowe says.

So, there was a great increase in global supply. But this trend has turned and the working-age population is now declining, with the decline projected to accelerate. The proportion of the population who are either too young or too old to work is rising, meaning the supply of workers available to meet the demand for goods and services has diminished.

The third factor affecting the supply side is climate change. Over the past 20 years, the number of major floods across the world has doubled and the frequency of heatwaves and droughts has also increased.

This will keep getting worse.These extreme weather events disrupt production and so affect prices – as we know all too well in Australia. But as well as lifting fruit and vegetable prices (and meat prices after droughts break and herd rebuilding begins), extreme weather can disrupt mining production and transport and distribution.

The fourth factor affecting the supply side is related: the transition from fossil fuels to renewables. This involves junking our investment in coal mines, gas plants and power stations, and new investment in solar farms, wind farms, batteries and rooftop solar, as well as extensively rejigging the electricity network.

It’s not just that the required new capital investment will be huge, but that the transition from the old system to the new won’t happen without disruptions.

So, energy prices will be higher (to pay for the new capital investment) and more volatile when fossil-fuel supply stops before renewables supply is ready to fill the gap.

Lowe foresees the inflation rate becoming more unstable through two channels. First, shocks to supply that cause large and rapid changes in prices.

Second, the global supply curve becoming less “elastic” (less able to respond to increases in demand by quickly increasing supply) than it has been in the past decade.

Lowe says bravely that none of these developments would undermine the central banks’ ability to achieve their inflation target “on average” - that is, over a few years – though they would make the bankers’ job more complicated.

Well, maybe. As he reminds us, adverse supply shocks can have conflicting effects, increasing inflation while reducing output and employment. The Reserve can’t increase interest rates and reduce them at the same time.

As Lowe further observes, supply shocks “also have implications for other areas of economic policy”. Yes, competition policy, for instance.

My conclusion is that managing the economy can no longer be left largely to the central bankers.

Read more >>

Yes, money does buy happiness* *terms and conditions apply

 Years ago, when our kids were young, we used to stay at a guesthouse in the mountains in the same week of January every year, as did various other families. When we met up with people we knew quite well, but hadn’t seen for 12 months, the greeting was always the same: D’ya have a good year?

So, has 2022 been a good year for you? Something similar is asked by the Australian Unity Wellbeing Index. Each year since 2001, researchers from Deakin University ask 2000 people how they’re doing. Are they satisfied with their standard of living, their relationships, purpose in life, community connectedness, safety, health and future security?

The index combines the answers to those questions into a single rating of our “subjective wellbeing”, somewhere between zero and 100. It’s too soon to have results for this year, of course, but the researchers do have them for the first two years of the pandemic – “the worst economic crisis in a generation, and the worst health crisis in a century”.

Guess what? The index actually rose from a low of 74.4 in 2019 to a high of 76.4 in 2020, before falling back a bit to 75.7 in 2021.

But don’t take those tiny changes literally. Allow for sampling error and the best conclusion is: no change. Indeed, in the survey’s 20 years, there’s been only minor variance around an average of about 75.4.

So I can tell you now that our wellbeing in 2022 will have been much the same as it always is, just as almost everyone at the guesthouse gave the same answer every year: “Not bad, not bad”.

The index’s stability from year to year – which is true of similar indexes in other rich countries – confirms a point its founder, Professor Bob Cummins, has been trying to convince me of since I first took an interest in the study of happiness.

Measures of satisfaction with life reflect both biological factors and situational factors. At the biological level, it seems humans have evolved to maintain a relatively optimistic and happy mood. This is controlled by “homeostatic” mechanisms similar to the one that keeps our body temperature stable – unless some situation (such as getting COVID) causes it to go off range.

The researchers say the situational factors most likely to adversely affect a person’s wellbeing equilibrium are insufficient levels of three key resources: money, connection with others, and sense of purpose.

A nationwide average bundles together those people whose wellbeing is reduced by such deficits with a greater number of people who are doing well.

So nothing in this finding denies that many people did it tough during the pandemic, whether monetarily or in their physical or mental health. It’s just that more of us stayed happy enough.

Remember, too, that the media almost always tells us about people with problems, not those doing OK. Similarly, medicos rightly focus on the unwell, not the well. But if you’re not careful, you can get an exaggerated impression of the world’s problems.

And when you look further than the average, you do see the pandemic making its presence felt. The index always shows people living alone, those in share houses and single parents having the least satisfaction with their lot.

But get this: those living alone and single parents enjoyed a big increase in perceived wellbeing. Why? Keep reading.

When the survey divides people according to their work status – unemployed, home duties, study, employed or retired – it always finds the unemployed far less satisfied than everyone else.

In the first year of the pandemic, however, the satisfaction of the unemployed leapt by 9 percentage points. Why? Maybe because the composition of the unemployed had changed a lot. Or maybe because, with many more people becoming unemployed, the stigma of being without a job was reduced.

But a much more obvious explanation is that, early in the pandemic, the rate of the JobSeeker unemployment benefit was temporarily doubled. Suddenly, it went from being below the poverty line to well above it. And wellbeing went up.

Trouble is, when the payment was cut back heavily in the second year, the satisfaction of the unemployed fell below what it was in the first place.

This supports a finding of “behavioural” economics: people suffer from “loss aversion” – we feel losses more deeply than we enjoy gains of the same size.

And it’s borne out by the survey’s finding that the satisfaction of all those people whose household income had fallen was more than 3 percentage points lower than that of those whose income was unchanged.

But. The satisfaction of those people whose income had risen was no higher than that of those whose income didn’t change.

The survey shows that people on the lowest incomes were much less satisfied than those on the next rung up. But it also confirms economists’ belief in “diminishing marginal returns”. The higher incomes rise, the smaller the increase in people’s satisfaction with their lives.

So, unless you’re really poor, don’t kid yourself that more money will make you a lot happier.

Read more >>

Hey RBA boomer, things have changed a lot since the 1970s

Sorry, but Reserve Bank governor Dr Philip Lowe’s call for ordinary Australians to make further sacrifice next year in his unfinished fight against “the scourge of inflation” doesn’t hold water. His crusade to save us all from a wage-price spiral is like Don Quixote tilting at windmills only he can see.

In one of his last speeches for the year, Lowe “highlighted the possibility of a wage-price spiral” in Australia. A lesson from the high inflation we experienced in the 1970s and ’80s is that “bringing inflation back down again after it becomes ingrained in people’s expectations is very costly and almost certainly involves a recession”.

He noted that this was a real risk in “a number of other advanced economies [which] are experiencing much faster rates of wages growth”.

But not to worry. “This is an area we are watching carefully.” The Reserve Bank board is “resolute in its determination to return inflation to target, and we will do what is necessary to achieve that”.

Oh. Really? Like the smartest of the business economists, I’ve been thinking that having raised the official interest rate by 3 percentage points in eight months, Lowe may have decided he’s done enough. But this tough-guy talk hints at more to come – maybe a lot more.

One thing I am pretty sure of, however. After the caning Lowe’s been given for saying repeatedly that he didn’t expect to be raising interest rates until 2024, when he does decide he has done enough, he won’t be saying so.

To leave his options open – and pacify the urgers in the financial markets who want him to do a lot more – he’ll say it’s just a pause to see how the medicine’s going down. And add something like “the board expects to increase interest rates further over the period ahead, but it is not on a pre-set course”.

One reason Lowe doesn’t have to raise rates as far as many overpaid money-market people imagine is that with real wages having fallen in recent years, and expected to keep falling, the nation’s employers are doing his job for him.

Raise mortgage interest rates or cut real wages – whichever way you do it, the result is to put the squeeze on households, to stop them spending as much (on the things the people who cut their wages are hoping to sell them – no, doesn’t make sense to me, either).

So, we’re back to Lowe’s professed fear of a wage-price spiral. The entire under-50 population must be wondering what such a thing could be. Lowe spelt it out while answering questions after his speech.

“The issue that many central banks have been worried about – and I include us in this – is [that] this period of high inflation will lead the workforce to say: ‘Well, inflation is high, I need compensation for that’.”

“And let’s say we all accepted the idea, which [has] a natural appeal: ‘inflation is 7 per cent, I should be compensated for that in my wages’. If that were to happen, what do you think inflation would be next year? Seven per cent, plus or minus.

“And then we’ve got to get compensated for that 7 per cent, and 7 per cent. . . This is what happened in the ’70s and ’80s and ... that turned out to be a disaster,” Lowe said.

“So I know it’s very difficult for people to accept the idea that wages don’t rise with inflation. And people are experiencing a decline in real wages. That’s tough. The alternative, though, is more difficult,” he added.

This is a reasonable description of how the wage-price spiral worked in the olden days. But as a plausible risk for today, it has two glaring weaknesses.

First, it assumes that if workers decide they want a 7 per cent pay rise, bosses have no choice but to hand it over. This is fantasy land.

The plain truth is that these days, workers lack the industrial muscle to force big pay rises on employers. The best-placed workers on enterprise agreements are getting rises of 3 to 4 per cent, but some are still getting rises in the twos.

The lowest-paid quarter of workers, dependent on award wage minimums, get their rises determined annually by the Fair Work Commission – but these are granted in retrospect, not prospect. This July, a handful of them got a rise of 5.2 per cent, but most got 4.6 per cent.

The bargaining power workers had in the ’70s has been reduced by more than four decades of globalisation, technological change and wage-fixing “reform”. In 1976, 52 per cent of workers were members of a union. Now it’s down to just 12.5 per cent.

Yet another reason a wage-price spiral couldn’t happen today is that most enterprise agreements run for three years. The system prohibits me from striking for a pay rise this year higher than the one I already agreed to two years ago.

The second respect in which Lowe’s fear of a wage-price spiral rising from the dead is silly is the assumption that if workers get a 7 per cent pay rise, businesses will automatically and easily put their prices up by 7 per cent. This makes sense arithmetically only if you think that wage costs constitute the whole of businesses’ costs. In truth, the Bureau of Statistics’ input-output tables say that economy-wide, wages account for only about a quarter of total input costs.

So, on average, a 7 per cent wage rise justifies a price rise of less than 2 per cent. Since business competitors would be paying much the same, you might think any firm that turned a 2 per cent cost increase into a 7 per cent price rise would be asking to be undercut by its competitors and lose its share of the market.

Of course, such an outrageous assault on the pockets of the industry’s customers would be possible if the industry was dominated by just a few big firms. They could – and have, and do – reach an unspoken agreement to each put their prices up by the same excessive amount.

It’s clear that Lowe knows a lot about how financial markets work, but not much about labour markets. But I find it hard to believe he could be so ill-informed as not to see the weaknesses in his wage-price spiral boogeyman.

The other possibility is that what’s really worrying him is a mass outbreak of oligopolistic pricing power. Getting that back under control really could take a recession.

Monetary policy (manipulating interest rates) is no cure for market power. The only answer is stronger competition policy and tougher policing by the Australian Competition and Consumer Commission. But neither the Reserve Bank nor Treasury has had much enthusiasm for this.

Much less controversial to blame inflation on greedy workers and tell the mums and dads it’s their duty to the nation to tighten their belts and lose their jobs until the problem’s solved.

Read more >>

Weakening competition is adding to our inflation woes

We’ve worried a lot about inflation and its causes this year, but in one important respect the economy’s managers have yet to join the dots. The most basic economics tells us that what stops prices rising more than they should is strong competition between firms. If competition has weakened, that will be part of our inflation problem.

But is there evidence that competition is less intense than it was? Yes, lots. It was outlined by Assistant Treasurer Dr Andrew Leigh in a recent speech.

The basic model of how markets work – the one lodged in the head of almost every economist – assumes “perfect competition”.

Markets are supposed to consist of a huge number of consumers and many producers, each of them too small to have any ability to influence the price of the products they’re selling. So the price is determined purely by the interaction of producers’ supply and consumers’ demand.

Competition between these small firms is so intense that, should any one of them be so foolish as to raise their price above what all the other firms are charging, consumers would immediately cease buying their product, and they’d go out backwards.

I doubt if that was ever an accurate description of any real-world market. But even if it approximated the truth at the time economists got it so firmly fixed in their minds – the late 19th century – all the years since then have seen firms getting bigger and bigger.

So much so that many key industries today have just a handful of firms – often no more than four – accounting for well over half the industry’s sales.

This has happened thanks to a century or two of firms using improvements in technology to pursue “economies of scale”. Up to a point, the more widgets you can produce from the same factory, the lower their average cost of production.

Firms do this in the hope of increasing their profits. But the magic of markets – when they’re working properly – is that your competitors also use the new technology to cut their production costs, then undercut your price to pinch some of your share of the market.

This is the competitive process by which the benefits of scale-economies end up mainly in the hands of consumers, in the form of lower prices. This is a big part of the reason we’re all so much richer than our great-grandparents were.

The digital revolution has moved scale-economies to a new stratosphere. It costs a lot to develop a new GPS navigation program, for instance, but once you’ve done it, you can produce a million or two million copies at negligible extra cost.

So, fundamentally, the move to fewer but much bigger firms is a good thing. Except for this: the bigger a firm’s share of the market, the greater its ability to influence the prices it charges. This is a key motivation for big firms to keep taking over smaller firms.

And when markets are dominated by three or four big firms, it’s easy for them to reach an unspoken agreement to use advertising, marketing and superficial product differentiation to compete with their rivals, while avoiding undermining existing prices and profit margins by starting a price war.

Similarly, when all the big firms in an industry are hit by similar big increases the costs of their imported inputs – caused, say, by pandemic or war-related shortages of supply – it’s easy for them to reach an unspoken understanding that they will use this opportunity to fatten their profit margins by raising their prices by more than the rise in input costs justifies.

Which is just what seems to have been contributing to the huge rise in consumer prices this year – though it’s far too soon for economic researchers to have hard evidence this is happening.

What we do have, according to Leigh, is a “growing body of evidence that suggests excessive market concentration can lead to economic problems”.

“Dominant firms in a market may have less incentive to carry out research and development. They may have less incentive to produce new products. And in some cases, they may have less incentive to pay their employees fairly.

“As you can imagine, the drag on the economy only becomes stronger and deeper with each and every concentrated market,” Leigh says.

In the past decade, there has been a huge increase in the number of studies – covering the US and many other countries – confirming that markets have become more concentrated. That is, a higher share of the market held by a few big firms.

But, Leigh says, “mark-ups” – the gap between firms’ costs of production and their selling prices – are one of the most reliable indicators of “market power”. That is, power to raise their prices by more than is justified by their increased costs of production.

Australian research led by Treasury’s Jonathan Hambur finds that industry average mark-ups increased by about 6 percentage points between 2003 and 2016. This fits with figures for the advanced economies estimated in a study by the International Monetary Fund over the same period.

Hambur finds that mark-ups for the most digitally intensive firms increased by 12 percentage points, compared with 4 percentage points for all other firms.

And also that industries experiencing greater annual increase in concentration had greater annual increases in their mark-ups.

Of course, none of this should come as a great surprise to those few economists who specialise in the study of IO – industrial organisation – the way the real-world behaviour of monopolies and oligopolies differs from the way simple textbook models of perfect competition would lead us to expect.

Institutionally, the responsibility for seeking to ensure “effective competition” in our highly oligopolised economy rests with the Australian Competition and Consumer Commission. But its efforts to tighten scrutiny of company takeovers and other ways of increasing a firm’s market power have met stiff resistance from the big business lobby.

This new evidence of increasing mark-ups suggests the econocrats responsible for limiting inflation should be giving the ACCC more support.

Read more >>

2022: The year our trust was abused to breaking point

As the summer break draws near, many will be glad to see the back of 2022. But there’s something important to be remembered about this year before we bid it good riddance. Much more than most years, it’s reminded us of something we know, but keep forgetting: the central importance of trust – and the consternation when we discover it’s been abused.

Every aspect of our lives depends on trust. Spouses must be able to trust each other. Children need parents they can trust and, when the children become teenagers, parents need to be able to trust them. Friendships rely on mutual trust.

Trust is just as important to the smooth functioning of the economy. Bosses need to be able to trust their workers; workers need bosses they can trust. The banking system runs on trust because the banks lend out the money we deposit with them; should all the depositors demand their money back at the same time, the bank risks collapse.

Just buying stuff in a shop involves trust that you won’t be taken down. Buying stuff on the internet requires much more trust. Tradies call on our trust when they demand payment before they start the job.

Our democracy runs on trust. We trust the leaders we elect to act in our best interests, not their own. Our country’s co-operation with other countries rests on trust. Of late, our relations with China, our major trading partner, have become mutually distrustful.

The trouble with trust, however, is that it can make us susceptible. And, as Melbourne University’s Tony Ward reminds us, it can be just too tempting to the less scrupulous to take advantage of our trusting nature.

They can get away with a lot before we wake up. But when we do, there are serious repercussions. Much worse, the loss of trust – some of it warranted; much of it not - makes our lives run a lot less smoothly.

The truth is that, as a nation, we’ve slowly become less trusting of those around us. But this year is notable for events where trust – or the lack of it – was central.

It’s widely agreed that the main reason the federal Coalition government was tossed out in May was the unpopularity of Scott Morrison. The Australian National University’s Australian Election Study has found that the two most important factors influencing political leaders’ popularity are perceived honesty and trustworthiness.

Its polling showed Morrison 29 percentage points behind Anthony Albanese on honesty, and 28 points behind on trustworthiness.

By contrast, many were expecting Daniel Andrews to be punished at the recent Victorian election for the harsh measures he insisted on during the pandemic. It didn’t happen. We don’t have fancy studies to prove it, but my guess is he retained the trust of the majority of voters.

The ANU study always asks questions about trust in government. This year it found 70 per cent of respondents agreeing that “people in government look after themselves” and only 30 per cent agreeing that “people in government can be trusted to do the right thing”.

This helps explain why the federal election was no triumph for Labor. The combined primary vote for the major parties fell to 68 per cent, the lowest since the 1930s. Labor’s own election report explains this as “part of a long-term trend driven by declining trust in government, politics and politicians”.

But don’t put all the blame on the pollies. This year opened our eyes to the risk we run of the businesses we deal with allowing our identification details and other private information to be stolen by hackers and made public.

Customers of Optus, Medibank and some other firms have learnt the hard way that the businesses who demand so much identification from us can’t be trusted to keep that information secure.

It’s been a wake-up call not only for those big businesses and others, but also for the new federal government. If businesses can’t be trusted to do the right thing, they must be required to do so by tighter regulation.

Oh no, not more red tape? Yes, and that’s my point. There’s nothing that generates extra expense and slows things down more than not being able to trust the people you must deal with.

Ward reminds us of the benefits of a high level of trust. It reduces “transaction costs” – the cost of doing business. “Profits and investments are higher if you don’t have to spend lots of time and money checking whether other parties are honest or not,” he says.

“People invest more in their own education if they believe a fair system will reward their efforts. If you think the system is rigged, why bother?”

Comparing countries, economists have found strong links between more social trust and higher levels of income. Trust is one of the top determinants of long-term economic growth.

And high-trust societies, with less distrust of science, had better outcomes in tackling COVID. That’s one respect in which we didn’t do too badly this year.

Read more >>

Who knew? The price of better government is higher taxes

Have you noticed? Since the change of government, the politicians have become a lot franker about the budgetary facts of life. And now the Parliamentary Budget Office has spelt it out: it’s likely that taxes will just keep rising over the next 10 years.

The great temptation for politicians of all colours is to make sure we don’t join the budgetary dots. On one hand, they’re going to improve childcare and health and education, do a better job on aged care and various other things. On the other, they’ll cut taxes.

In short, they’ve discovered a way to make two and two add to three.

The attraction of that relatively new institution, the Parliamentary Budget Office, is that it reports to the Parliament, meaning it’s independent of the elected government. Each year, sometime after the government has produced its budget, the office takes the decisions and figurings and examines whether they are sustainable over the “medium term” – an econocrats’ term for the next 10 years.

They do this by accepting the government’s present policies and mechanically projecting them forward for a further six years beyond the budget’s published figures for the budget year and the following three financial years of “forward estimates”.

Note that these mechanical projections are just projections – just arithmetic. They’re not forecasts of what will happen. No one but God knows what will happen to the economy over the next year, let alone the next 10.

No one putting together the Morrison government’s pre-election budget of April 2019 – the one saying the budget would soon be “back in black” – foresaw that the arrival of a pandemic 11 months later would knock it out of the ballpark, for instance.

Projections don’t attempt to forecast what will happen. Rather, they move the budget figures forward based on plausible assumptions about what the key economic variables – population growth, inflation, for instance – may average over the projection period.

So, projections are not what will happen, but what might happen if the government left its present policies unchanged for 10 years. They give us an idea of what changes in policy are likely to be needed.

Media reporting of the budget office’s latest medium-term projections focused on its finding that, if there are no further tax cuts beyond the stage three cuts legislated for July 2024, the government’s collections of personal income tax may have risen 76 per cent by 2032-33.

The average rate of income tax paid by all taxpayers is projected to reach 25.5 cents in the dollar before the stage three tax cut drops it to 24.1 cents. But then it could have risen to 26.4 cents by 2032-33 – which would be an all-time high.

Why? Bracket creep. Income is taxed in slices, with the slices taxed at progressively higher rates. So, as income rises over time, a higher proportion of it is taxed at higher rates, thus pushing up the average rate of tax on all the slices.

Like the sound of that? No. Which is why the media gave it so much prominence. But there’s much more to be understood about that prospect before you start writing angry letters to your MP.

The first is that, according to the projections, even with such unrestrained growth in income tax collections, the rise in total government revenue wouldn’t be sufficient to stop the budget deficit growing a bit, year after year.

Why not? Because of the strong projected growth in government spending. That’s the first thing to register: the reason tax collections are likely to rise so strongly is that government spending is expected to rise so strongly.

Why? Because that’s what we want. The pollies know we want more and better government services – which is why no election passes without both sides promising to increase spending on this bauble and that.

What neither side ever does in an election campaign is present the bill: “we’re happy to spend more on your favourite causes but, naturally, you’ll have to pay more tax to cover it”. Indeed, they often rustle up a small tax cut to give you the opposite impression: that taxes can go down while spending goes up.

The budget office’s projections suggest that total government spending will rise from 26.2 per cent of gross domestic product in the present financial year to 27.3 per cent in 2032-33. This may not seem much, but it’s huge.

Nominal GDP – the dollar value of the nation’s total production of goods and services, and hence, the nation’s income – grows each year in line with population growth, inflation and any real increase in our average standard of living. So, for government spending to rise relative to GDP, it must be growing faster even than the economy is growing.

Briefly, the spending growth is explained by continuing strong growth in spending on the National Disability Insurance Scheme, the growing interest bill on the government’s debt, and the rising cost of aged care.

This being so, there seems little doubt we’ll be paying a bit more tax – a higher proportion of our income – most years over the coming 10, and probably long after that.

But that’s not to say things will pan out in the way described by the budget office and as trumpeted by the media. For a start, it’s unlikely any government would go for six years without a tax cut.

It’s true that governments of both colours rely heavily on bracket creep – aka “the secret tax of inflation” – to square the circles they describe during election campaigns; to ensure two and two still add up to four.

But they’re not so stupid as never to show themselves going through the motions of awarding a modest tax cut every so often – confident in the knowledge that continuing bracket creep will claw it back soon enough.

The next point is that the overall average tax rates the budget office quotes are potentially misleading. Every individual taxpayer has their own average rate of tax, with high income-earners having a much higher average than people with low incomes.

But when the budget office works out the average for all taxpayers – the average of all the averages, so to speak – you get a number that accurately described the position of surprisingly few people. It’s like the joke about the statistician who, with his head in the oven and his feet in the fridge, said that, on average, he was perfectly comfortable.

There are plenty of things a government could do to reduce the tax concessions for high income-earners (like me) and to slant any tax cuts in favour of people in the bottom half, which would allow it to raise much the same revenue as the budget office envisages without raising the average tax rate paid by the average (that is, the median) individual taxpayer by nearly as much as the budget office’s figures suggest.

Fearless prediction: just such thinking will be what leads the Albanese government to make a start next year by rejigging the size and shape of the stage three tax cuts.

Read more >>

Weak starting point for next year’s threats to the economy

It’s clear the economy’s started slowing, with the strong bounceback from the lockdowns nearing its end. That’s before we’ve felt much drag from the big rise in interest rates. Or the bigger economies pulling us lower, which is in store for next year.

To be sure, the economy’s closer to full employment than we’ve been half a century. But limiting the decline from here on will be a tricky task for Anthony Albanese and, more particularly, Reserve Bank governor Philip Lowe.

The Australian Bureau of Statistics’ “national accounts” for the three months to the end of September, published this week, showed real gross domestic product – the nation’s total production of goods and services – growing by just 0.6 per cent during the quarter, and by 5.9 per cent over the year to September.

Focus on the 0.6 per cent, not the 5.9 per cent – it’s ancient history. Most of it comes from huge growth of 3.8 per cent in the December quarter of last year, which was the biggest part of the bounceback following the end of the second lockdown of NSW, the ACT and Victoria.

Since then, we’ve had quarterly growth of 0.4 per cent, 0.9 per cent and now 0.6 per cent. That’s the slowing. Quarterly growth of 0.6 per cent equals annualised growth of about 2.5 per cent. That’s about the speed the economy was growing at before the pandemic, which we knew was on the weak side.

Dig deeper into the figures, and you see more evidence of slowing. Strong spending by consumers was pretty much the only thing keeping the economy expanding last quarter. Consumption grew by a seemingly healthy 1.1 per cent, which accounted for all the growth in GDP overall of 0.6 per cent. The various other potential contributors to growth – business investment spending, new home building, exports and so forth – cancelled each other out.

But get this: that growth of 1.1 per cent was half what it was in the previous quarter. And what were the main categories of strong spending by consumers? Spending in hotels, cafes and restaurants was up by 5.5 per cent in the quarter.

Spending on “transport services” – mainly domestic and overseas travel – was up almost 14 per cent. And purchase of cars was up 10 per cent.

Anything strike you about that list? It’s consumers still catching up after the end of the lockdowns, when most people were still earning income, but were prevented from spending it. We couldn’t go out to hotels, cafes and restaurants, interstate travel was restricted, and overseas holidays were verboten.

As for buying a new car, an earlier global shortage of silicon chips and container shipping mean few were coming into the country.

Get it? Much of the strong consumer spending that kept the economy moving last quarter was driven by life getting back to normal after the lockdowns and the easing of pandemic-caused supply shortages. It’s a temporary catch-up, that won’t continue for long.

Now let’s look at what the quarterly accounts tell us about the state of households’ finances. Despite their strong consumer spending, their real disposable income actually fell a fraction during the quarter, taking the total fall over the year to September to 2.6 per cent.

Why did households’ income fall? Because prices rose faster than wages did. How did households increase their spending while their income was falling? By cutting the proportion of their incomes they’d been saving rather than spending.

After the first lockdown in 2020, the household saving rate leapt to more than 19 per cent of disposable income. Why? Because people had lots of income they simply couldn’t spend.

But the rate of saving has fallen sharply since then. And in the September quarter it fell from 8.3 per cent of income to 6.9 per cent – almost back to where it was before the pandemic.

As Callam Pickering, of the Indeed jobs site, explains, “households have been relying on their savings, accrued during the pandemic, to maintain their spending in recent quarters”. Lately, however, they’ve “been hit from all angles, with high inflation, falling [house] prices and mortgage repayments all weighing heavily on household budgets”.

“As household saving continues to ease, the ability of households to absorb the impact of higher prices and rising interest rates will also diminish,” he says.

By the end of September, the hit from higher interest rates was just getting started. Of the 3 percentage-point increase in the official interest rate we know has happened, only 0.75 percentage points had yet reached home borrowers.

So, the hit to growth from government monetary policy is only starting. As for the other policy arm, fiscal policy, we know from the October budget it won’t be helping push the economy along. And in the September quarter, falling spending on infrastructure caused total public sector spending to subtract a little from overall growth in GDP.

A similar subtraction came from net exports. Although the volume of exports rose by 2.7 per cent during the quarter, the volume of imports rose by more – 3.9 per cent. A big part of this net subtraction came from the reopening of our international borders. Our earnings from incoming travellers rose by 18.6 per cent, whereas the cost of our own overseas travel jumped by 58 per cent.

Finally, self-righteous business people are always telling us that if we want to real wages to rise rather than fall, there’s an obvious answer: we’ll have to raise our productivity.

Sorry, not so simple, preacher-man. The accounts show that real labour costs to employers per unit of output fell by 2.6 per cent over the year to September.

Meaning that after allowing for the productivity improvement the nation’s employers gained, the increase in wages and other labour costs were a lot less than the increase in the prices they charged.

This suggests business profits are much better placed to weather next year’s hard times than their workers’ and customers’ pockets are. Not a good omen.

Read more >>

Both sides exaggerate significance of wage bargaining changes

Do you realise, in just the six months it’s been in office, the Albanese government has passed 61 bills, covering most of what it promised to do at the May election?

Just last week it passed the National Anti-Corruption Commission Bill and the controversial Secure Jobs, Better Pay bill. According to Anthony Albanese, the latter involved “the biggest workplace reforms since the 1970s” and its passing made last Friday “a huge day for working Australians”.

Sorry, this government’s degree of effort and expedition far exceeds anything achieved by its predecessor and some of its measures are truly memorable, but its industrial relations changes are nothing like that monumental.

For one thing, Albanese has yet to act on his promises to regulate the gig economy, act decisively to reduce wage theft and reduce the use of casuals and labour-hire companies.

But it’s not just Albanese who’s been laying it on too thick. Indeed, the prize for the biggest storm-in-a-teacup of the year must surely go to the Secure Jobs, Better Pay bill. Its passing was certainly “controversial” – the enormous fuss made by the various employer groups made sure of that – but the degree of controversy generated is an unreliable guide to the likely threat – or promise – from the changes made.

Two fearless predictions. First, the changes won’t be nearly as bad as the lobbyists’ scaremongering claimed. But equally, they won’t have nearly as much effect on the jobs and pay of “working Australians” as the government wants us to believe.

The employer groups’ repeated claims that the government’s efforts to increase the scope for “multi-employer bargaining” would lead to widespread strikes and job losses seems intended to bamboozle those not old enough to remember industrial relations when they really were red in tooth and claw.

Strike action peaked in the 1970s, when the number of strikes averaged 2370 a year, with total days of work lost averaging 3.1 million a year, and days lost per 1000 workers averaging 540. As in all the rich countries, strike action has declined markedly since then, with the 2010s seeing only 200 strikes per year, costing 145,000 days lost, or 14 days per 1000 workers.

The notion that Albanese’s modest changes will return us to anything remotely approaching the 1970s is risible.

In those days, when inflation was far higher than it is now, our long-gone system of compulsory arbitration had the perverse effect of encouraging many quite short strikes. These days, old IR hands know that if a strike lasts more than a day or two it’s a sign the union has lost. It will then take years for whatever small pay rise the workers end up getting to make up for the many days’ pay they lost.

Ask yourself this: how are widespread strikes supposed to lead directly to widespread job losses? They don’t. They lead to some workers losing their jobs only because the majority who don’t lose their jobs are getting wage rises so big that employers genuinely can’t afford them. It’s not a reasoned argument, it’s an attempt to frighten the unthinking.

What employers really fear is a move from bargaining at the level of the individual business or enterprise to bargaining at an industry-wide level, which would make it easier for the unions to achieve pay rises in businesses with few union members.

Although industry-wide bargaining remains outlawed by the Fair Work Act, the employer groups have chosen to pretend that the government’s cautious extension of access to multi-enterprise bargaining is pretty much the same thing.

Nonsense. As Adelaide University’s Professor Andrew Stewart explains, the new provision for “single- (or common-) interest” multi-employer bargaining is hedged about with limitations and protections. Unions will not be able to rope in small businesses employing fewer than 20 workers. Larger employers can only be included without their consent if a majority of their workers wants to bargain.

Access to this form of bargaining must be approved by the Fair Work Commission, which will permit employers to participate only if they are sufficiently “comparable” to the other employers. An employer with an existing single-enterprise agreement won’t be able to switch to a multi-employer agreement.

But those employers included in such bargaining will be required to bargain in “good faith” – be genuinely committed to reaching an agreement, and unions will be permitted to strike – provided this is approved by a secret ballot of employees.

A significant change is that, when either single- or multi-enterprise bargaining becomes intractable, the commission will resolve the dispute by arbitration.

The other new provision for “supported bargaining” of multi-employer agreements is aimed at helping low-paid workers in strongly female industries such as childcare and aged care. This is likely to produce some significant pay rises. Why? Because the “support” will come from the third party that will end up covering the cost of the pay rise – the federal government.

Apart from that, the low union membership in most of the relevant enterprises says there’ll be few strikes and few big pay rises.

Read more >>

Treasury's advice now back in favour with the government

The Coalition’s practice of sacking a bunch of government department heads whenever it gets back to office is clearly calculated to discourage bureaucrats from giving frank advice. Fortunately for us, the Albanese government is not as arrogant.

In my experience, weak managers surround themselves with yes-persons, so their brains – and, as they see it, their authority – aren’t challenged.

Strong managers want frank advice from their experts, so they’re less likely to stuff up. They’re confident of their ability to sift through conflicting advice and pick the best way forward.

This Liberal policy of frightening bureaucrats into keeping their opinions to themselves began when they returned to power in 1996 under John Howard. It was repeated when Tony Abbott got back in 2013, sacking then Treasury secretary Dr Martin Parkinson and various other Treasury-related department heads (narrowly missing Treasury’s incumbent, Dr Steven Kennedy).

Their crime, it seemed, was that they actually believed in the Rudd-Gillard government’s policy of using an emissions trading scheme to limit carbon emissions. Guilty as charged. Like almost all economists, Treasury accepted the scientists’ advice on the science, and believed the best tools for fighting climate change were economic instruments such as “putting a price on carbon”. Labor’s Department of Climate Change was staffed manly by Treasury people.

But the Libs’ peak disdain for the public service came under Scott Morrison who, upon attaining the top job, told the bureaucrats he wanted no advice from them, just diligent implementation of the policy decisions made by Cabinet.

What gave this bunch of not-so-super men (and the odd woman) the arrogance to believe they could govern wisely without the bureaucrats’ policy advice? Mainly, their ability to fall back on the small army of taxpayer-funded, but unaccountable ministerial staffers, mainly youngsters with political ambitions and the willingness to interpose themselves between the minister and the department.

These young punks, who think they outrank the most senior public servants, are generally big on politics, but weak on policy. Which, you’d have to say, was the Coalition cabinet’s “revealed preference”.

The apotheosis of this decadence was revealed in evidence to the robo-debt royal commission last week. Advice sought from an outside law firm, which found that the government’s cost-cutting scheme was unlawful, was paid for but not passed up the line to the minister – presumably because the bureaucrats judged it would not be welcome.

But in a little-noticed part of a recent speech by Treasurer Jim Chalmers, he left no doubt that, under Labor, Treasury’s advice would be sought, and used to improve the government’s decisions. What’s more, Treasury’s ability to convey its views to the public would be enhanced.

Chalmers noted that, even after the government had dealt with the inflation challenge, “we will have to manage a budget weighed down by persistent structural spending pressures”. Doing this required new thinking and deeper thinking, he said.

“It requires us rebuilding the evidence base for policymaking. Because, to get better, more-forward-looking economic policies, we need better, more-forward-looking policy foundations.”

Chalmers revealed six ways in which he will be “rebuilding the evidence base for policymaking”. One was “putting Treasury back at the centre of climate modelling again”, to build on “the new approach to climate risks, costs and opportunities” revealed in last month’s budget papers.

Second, Treasury’s annual statement on “tax expenditures” would be made “more accessible, more useful analysis of what tax concessions are costing the budget” and their effect on the distribution of income between high and low earners.

Economists have long believed that such “tax expenditures” are equivalent to actual government spending in their effect on the budget balance, and should be subject to just as much critical reassessment as actual spending.

But the Libs didn’t agree. Since taxes are evil, anything you do to reduce them must be a good thing, even if the concessions go to some (usually higher-earning) taxpayers and not others. They sought to play down the tax expenditure statement – which hugely annoys the interest groups receiving concessions on such things as superannuation savings, and the 50 per cent discount on taxing capital gains – by renaming it the “tax benchmark and variations statement”. Not anymore.

The third, even more significant change will be the appointment of an “evaluator-general” to regularly and publicly examine the effectiveness of government spending programs. Many programs don’t do much to achieve their stated objectives, but ministers and their department heads are notoriously reluctant to have them rigorously examined, for fear of embarrassment.

But, as first proposed by economist Dr Nicholas Gruen, such a person and their agency would have similar powers and independence to those of the much-feared Auditor-General. This should work, provided governments couldn’t do what Morrison did to the Auditor-General: cut his funding.

The appointment of an evaluator-general is official Labor policy, and has been championed by the assistant assistant treasurer, Dr Andrew Leigh, whose outstanding economic expertise is negated by his failure to align with any Labor faction.

No doubt Leigh will be keen for the evaluator to make use of the latest in evidence-based decision-making, randomised controlled trials.

The point is that one thing Treasury (and the Finance department) should be hugely knowledgeable about – but aren’t – is what policies work, and what policies don’t. An evaluator-general will fill this vacuum.

Fourth, Treasury will work with Finance Minister and Minister for Women Katy Gallagher to “ensure gender considerations are at the core of our work”, building on last month’s “gender-responsive budgeting”.

Fifth, Treasury will produce Australia’s first “national wellbeing statement” next year, which will be “a hard-headed way to gauge progress by recognising that a robust and resilient economy relies on robust and resilient people and communities”.

And finally, Chalmers will step up production of the Intergenerational Report from five-yearly to three-yearly, in the middle year of each parliamentary term. He promises the document will be “depoliticised”.

It’s true that former treasurer Joe Hockey trashed this exercise by turning it into a blatant attack on his Labor predecessors. It was hard to take subsequent reports seriously, especially when they imposed an artificial cap on tax collections over the next 40 years, while letting government spending run wild.

We need the report to be a much more balanced assessment of future budgetary challenges, not just a Treasury tract on the supposed evils of runaway government spending. We need more acknowledgement of the possible effects of climate change on the budget over the next 40 years – a start to which was made in last month’s budget.

And it would be nice if the report lived up to its name by having much more to say about intergenerational equity issues and trends, such as the effect of ever-rising house prices, and the longer-term consequences of the way the Howard government kept stacking the odds in favour of the old at the expense of the young, particularly favouring the self-proclaimed “self-funded retirees” (who never mention the huge superannuation tax concessions they’ve been given, nor that many of them also get a part-pension).

So, well done, Jim. With better advice and a better “evidence base”, now all Labor needs is the courage to stand up to a few powerful interest groups, including those industries that get the relevant union to plead their case in the new-look Canberra.

Read more >>