Monday, July 31, 2023

Another rise in interest rates is enough already

Whatever decision the Reserve Bank board makes about interest rates at its meeting tomorrow morning – departing governor Dr Philip Lowe’s second-last – the stronger case is for no increase. Indeed, I agree with those business economists saying we’ve probably had too many increases already.

If so – and I hope I’m wrong – we’ll miss the “narrow path” to the sought-after “soft landing” and hit the ground with a bang. We’ll have the recession we didn’t have to have. (That’s where recession is measured not the lazy, mindless way – two successive quarters of “negative growth” – but the sensible way: a big rise in unemployment over just a year or so.)

For those too young to know why recessions are dreaded, it’s not what happens to gross domestic product that matters (it’s just a sign of the looming disaster) but what happens to people: lots of them lose their jobs, those leaving education can’t find decent jobs, and some businesses collapse.

Market economists usually focus on guessing what the Reserve will do, not saying what it should do. (That’s because they’re paid to advise their bank’s money-market traders, who are paid to lay bets on what the Reserve will do.)

That’s why it’s so notable to see people such as Deloitte Access Economics’ Stephen Smith and AMP’s Dr Shane Oliver saying the Reserve has already increased interest rates too far.

Last week’s consumer price index for the June quarter gave us strong evidence that the rate of inflation is well on the way down. After peaking at 7.8 per cent over the year to December, it’s down to 6 per cent over the year to June.

As we’ve been told repeatedly, this was “less than expected”. Yes, but by whom? Usually, the answer is: by economists in the money markets. Here’s a tip: what money-market economists were forecasting is of little interest to anyone but them.

That almost always proves what we already know: economists are hopeless at forecasting the economy. Even after the fact, and just a week before we all know the truth. No, the only expectation that matters is what the Reserve was expecting. Why? Because it’s the economist with its hand on the interest-rate lever.

So, it does matter that the Reserve was expecting annual inflation of 6.3 per cent. That is, inflation’s coming down faster than it thought. Back to the drawing board.

The Reserve takes much notice of its preferred measure of “underlying” inflation. It’s down to 5.9 per cent. But when the economy’s speeding up or slowing down, the latest annual change contains a lot of historical baggage.

This is why the Americans focus not on the annual rate of change, but the “annualised” (made annual) rate, which you get by compounding the quarterly change (or, if you can’t remember the compounding formula, by multiplying the number by four).

Have you heard all the people saying, “oh, but 6 per cent is still way above the target of 2 to 3 per cent”? Well, if you annualise the most recent information we have, that prices rose by 0.8 per cent in the June quarter, you get 3.3 per cent. Clearly, we’re making big progress.

But the next time someone tells you we’re still way above the target, ask them if they’ve ever heard of “lags”. Central Banking 101 says that monetary policy (fiddling with interest rates) takes a year or more to have its full effect, first on economic activity (growth in gross domestic product and, particularly, consumer spending), then on the rate at which prices are rising. What’s more, the length of the lag (delay) can vary.

This is why central bankers are supposed to remember that, if you keep raising rates until you’re certain you’ve done enough to get inflation down where you want it, you can be certain you’ve done too much. Expect a hard landing, not a soft one.

Since the road to lower inflation runs via slower growth in economic activity, remember this: the national accounts show real GDP slowing to growth of 0.2 per cent in the March quarter, with growth in consumer spending also slowing to 0.2 per cent.

How much slower would you like it to get?

The next weak argument for a further rate rise is: “the labour market’s still tight”. The figures for the month of June showed the rate of unemployment still stuck at a 50-year low of 3.5 per cent, with employment growing by 32,600.

But the nation’s top expert on the jobs figures is Melbourne University’s Professor Jeff Borland. He notes that, in the nine months to August last year, employment grew by an average of 55,000 a month – about double the rate pre-pandemic.

Since August, however, it’s grown by an average of 35,600 a month. Sounds like a less-tight labour market to me.

And Borland makes a further point. Whereas the employment figures measure filled jobs, the actual number of jobs can be thought of as filled jobs plus vacant jobs – which tells us how much work employers want done.

This is a better indicator of how “tight” the labour market is. And, because vacancies are falling, the growth in total jobs has slowed much faster. Since the middle of last year, part of the growth in employment has come from reducing the stock of vacancies.

Another thing the Reserve (and its money-market urgers) need to remember is that, when it comes to slowing economic activity to slow the rise in prices, interest rates (aka monetary policy) aren’t the only game in town.

Professor Ross Garnaut, also of Melbourne University, wants to remind us that “fiscal policy” (alias the budget) is doing more to help than we thought. The now-expected budget surplus of at least $20 billion means that, over the year to June 30, the federal budget pulled $20 billion more out of the economy than it put back in.

Garnaut says he likes the $20 billion surplus because, among other reasons, “we can run lower interest rates”.

One last thing the Reserve board needs to remember. Usually, when it’s jamming on the interest-rate brakes to get inflation down, the problem’s been caused by excessive growth in wages. Not this time.

Since prices took off late in 2021, wages have fallen well behind those prices. Indeed, wages haven’t got much ahead of prices for about the past decade. And while consumer prices rose by 7 per cent over the year to March, the wage price index rose by only 3.7 per cent.

This has really put the squeeze on household incomes and households’ ability to keep increasing their spending. And that’s before you get to what rising interest rates are doing.

Dear Reserve Bank board members, please remember all this tomorrow morning.

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Wellbeing? Measure what matters, then start fixing it

In this rushing world, it’s easy for the new, the exciting, the entertaining or the worrying to crowd out the merely important. But that’s one reason mastheads have columnists. To say, hey, don’t overlook this, it’s important.

If, like all sensible people, you think there’s more to life than gross domestic product – more than “the economy”, narrowly defined – you need to take more notice of Treasurer Jim Chalmers’ long-promised Measuring What Matters wellbeing framework, released on Friday.

Taken as just another news story, it was a remarkably unremarkable document. It gathered 50 statistical indicators of Australians’ wellbeing, only a few of which were the standard economic indicators.

Of these, 20 show an improvement since the early 2000s, 12 have deteriorated, while the rest have shown little change or mixed outcomes. Our headline shouted the astonishing news: “We’re living longer, but cuddly animals are on the decline.”

Meanwhile, the government’s unceasing critics had much sneering fun pointing out how outdated some figures were. Did you see they say home owners are finding it easier to repay their mortgages?

Hopeless. It’s obviously just Labor’s “pitch to progressives living in Green and teal colonies”.

Actually, it’s a genuine effort to acknowledge and pay more attention to all the aspects of our lives that matter in addition to how many of us have jobs, how much we earn and what we’re spending it on.

The people who know a lot and care a lot about our wellbeing, in all its dimensions – such as Warwick Smith, director of the Centre for Policy Development’s Wellbeing Initiative – were much less critical. They said it was a good start, and could be improved and built upon, with the ultimate objective of having our greater consciousness of these other priority areas doing more to influence what the government was spending its time trying to improve.

Few economists would disagree with the frequent claim that GDP isn’t a good measure of wellbeing or progress. Indeed, the first person to say it was the bloke who invented GDP in the 1930s, Simon Kuznets.

It’s just that, economists being economists, they’ve continued to focus on GDP – economic growth – and left the better measures of wellbeing to others. Politicians have continued to focus on economic growth because that’s what the rich and powerful care most about. They’re hoping it will make them richer and more powerful.

It’s precisely because our leaders have been so focused on GDP as a measure of economic growth that our economic statistics are comprehensive and up to date, but our measurements of other things aren’t.

So, getting fair dinkum about “measuring what matters” involves giving the Australian Bureau of Statistics more money to measure the other things that matter more fully and more frequently.

Having been a bean counter in both my careers, I know the boring, pettifogging importance of measurement. As they say, what gets measured gets managed. You want to get your map sorted before you take off into the jungle.

But what are the other, non-standard things that matter most to our wellbeing? This is what we got on Friday: the government’s decision about the key components of wellbeing. This is the wellbeing “framework”.

It nominates five dimensions of wellbeing. First, health. “A society in which people feel well and are in good physical and mental health, can access services when they need, and have the information they require to take action to improve their health,” the framework says.

Second, security. “A society where people live peacefully, feel safe, have financial security and access to housing.”

Third, sustainability. “A society that sustainably uses natural and financial resources, protects and repairs the environment and builds resilience to combat challenges.”

Fourth, cohesion. “A society that supports connections with family, friends and the community, values diversity, promotes belonging and culture.”

And finally, prosperity. “A society that has a dynamic, strong economy, invests in people’s skills and education, and provides broad opportunities for employment and well-paid, secure jobs.”

Each of these five “themes” (dimensions is a better word) are “underpinned” by the need for “inclusion, equity and fairness” (but if there’s a difference between equity and fairness, I don’t know it).

I think that covers the bases. Sounds a nice place to live. It puts the economy into a broader, more balanced context. The economy is vitally important – it’s our bread and butter, after all – but so are many other things.

If we nail it on prosperity but go backward on the others, why would that be good? The rich could survey the ruins around them and say, I won!

And there’s a lot of interdependence. Good luck with your economy once you’ve irreparably damaged the natural environment on which it depends.

On many of these dimensions, what we need to know is not so much how well we’re doing on average, but who’s missing out and needs help. Not who’s included, but who’s excluded. (Something a Voice would make it harder to forget.)

But measurement is just a means to an end. Until what we know affects what our governments do, it’s just box-ticking.


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Friday, July 28, 2023

Why inflation is easing while rents are rising - and will keep going

It never rains but it pours. With the prices of so many things in the supermarket shooting up, now it’s rents that are rising like mad. Actually, while the overall rate of inflation is clearly slowing, rents are still on the up and up. What’s going on?

The Australian Bureau of Statistics’ consumer price index (CPI) showed prices rising by 0.8 per cent over the three months to the end of June, and by 6 per cent over the year to June. That’s down from 7.8 per cent over the year to December.

But rents in Sydney rose by 7.3 per cent over the year to June, up from 3.3 per cent over the year to December. Rents in Melbourne are now up by 5 per cent, compared with 2.2 per cent to last December.

But hang on. Those increases seem low. I’ve been reading and hearing about rent increases much bigger than that. What gives?

You’ve been reading about bigger rent increases than the CPI records because what gets most notice in the media is what economists call “advertised” rents – the asking price for presently vacant properties that have been listed with real estate agents.

So, this is the most relevant price for someone who’s decided to rent, or is wishing to move. Remember, however, in normal times landlords don’t always get as much as they ask for initially. Times like now, when the market’s so tight, they may end up with more.

But, each month, only 2 or 3 per cent of properties have a change in tenants. So most people are existing renters, wanting to sit tight, not move. It’s a safe bet they’re paying less that the price being asked of new tenants. And, though their rent will be increased soon enough, it hasn’t been yet.

The stats bureau’s increases are lower than the asking price because they include the rents actually being paid by all capital-city renters, not just the new ones.

But if the asking price is a lot higher than the average of the rents being paid by everyone, this is a good sign the average will keep going up. The rent increase is working its way through the system, so to speak.

But why are asking prices rising so much? Ask any economist, and they’ll tell you without looking: if the demand for rental accommodation exceeds the supply available, prices will rise.

That’s true. And the way we know it’s true is that vacancy rates are much lower than usual.

It’s when vacancy rates are low that landlords know now would be a good time to put up the rent. If the landlord has borrowed to buy the rental property, the rise in the interest rates they’re paying will make them very keen to do so.

But more than half of all rental properties are owned debt-free. Those landlords will probably also be keen to take advantage of this (surprisingly rare) chance to increase their prices by a lot rather than a little.

When demand is outstripping supply, the economists’ knee-jerk reaction is that we need more supply. Rush out and build a lot more rental accommodation.

But the economists who actually study the rental market aren’t so sure that’s called for. If you look back over the past decade, you see little sign that the industry has had much trouble keeping the supply up with demand.

If anything, the reverse. Until the end of 2021, rents went for years without rising very fast. Especially compared with other consumer prices, and with people’s incomes. Indeed, there were times when rents actually fell.

You didn’t know that? That’s because the media didn’t tell you. Why? Because they thought you were only interested in bad news. (And they were right.)

What’s too easily forgotten is all the ructions the rental market went through during the pandemic. What’s happening now is a return to something more normal. It’s all explained in one of the bureau’s information papers.

Official surveys show that renters tend to younger and have lower incomes than homeowners, and to devote a higher share of their disposable (that is, after-tax) income to housing costs. This is why so many renters feel the recent rent rises so keenly. And also, why the pressure is greater on people renting apartments rather than houses.

The pandemic, with its changes in population flows, vacancy rates and renters’ preferences, had big effects on rents and renters. Early in the pandemic, demand for rental properties in the inner-city markets (that is, within 12.5 kilometres of the CBD) of Sydney and Melbourne declined, as international students returned home, international migration stopped and some young adults moved back in with their parents.

Some landlords offering short-term holiday rentals switched to offering longer-term rental, further increasing the supply of rental accommodation. And the need to work from home prompted some renters to move from the inner city to suburbs further out, where the same money bought more space.

This is why inner-city rents fell during the first two years of the pandemic. Also, state governments introduced arrangements helping tenants who’d become unemployed or lost income to negotiate temporary rent reductions.

But inner-city rental markets began tightening up in late 2021, as the lockdowns ended and things began returning to normal. Some singles who’d gone back home or packed into a share house began seeking something less crowded. And, eventually, international students began returning.

So, we’ve gone from the supply of rental accommodation exceeding demand, back to stronger demand. Rents that were low or even falling are going back up.

As an economist would say, with the pandemic over, the rental market is returning to a new “equilibrium” – a fancy word for balance between supply and demand.

What we’re seeing is not so much a “crisis” as a catch-up. One reason it’s happening so fast is the higher interest rates many landlords are paying. But another reason renters are finding it so hard to cope with is that other consumer prices have risen a lot faster than their disposable incomes have.

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Monday, July 24, 2023

Beating inflation shouldn't just be left to higher interest rates

Everyone’s heard the surprising news that last financial year’s budget is now expected to run a surplus of about $20 billion, but few have realised the wider implications. They strengthen the case for relying less on interest rates to fight inflation.

But first, the news is a reminder of just how bad economists are at forecasting what will happen to the economy – even in not much more than a year’s time. Which shows that economists don’t know nearly as much about how the economy works as they like to imagine – and like us to believe.

Then-treasurer Josh Frydenberg’s budget in March last year forecast a budget deficit in 2022-23 of $78 billion. By Jim Chalmers’ second go at the budget last October, that became a deficit of about $37 billion.

By the following budget, in May, the best guess had turned into a surplus of $4 billion. And just two months later – and that financial year actually over – the best guess is now a surplus of about $20 billion.

That’s a forecasting turnaround, over the course of only about 15 months, of almost $100 billion, or 4 per cent of gross domestic product.

What did Treasury get so wrong? It grossly underestimated the growth in tax collections. This was partly because it assumed a fall in the prices of our key commodity exports that didn’t happen, thus causing the company tax paid by our miners to be higher than expected.

But mainly because collections of income tax were much higher than expected. The economy grew at close to full capacity, so more people found jobs and many part-time workers got more hours or became full-time.

A huge number of new jobs have been created, almost all of them full-time. Do you realise that a higher proportion of people aged over 15 have paid employment than ever before? The rate of unemployment fell to its lowest in 50 years and many people who’d been unable to find a job for many months finally succeeded.

Obviously, when people find work, they start paying income tax, and stop needing to be paid unemployment benefits. So full employment is excellent news for the budget.

But the rapid rise in the cost of living during the year caused workers to demand and receive higher pay rises, even though those rises generally fell well short of the rise in prices.

So all the people who already had jobs paid more tax, too. But not only that. Our “progressive” income tax scale – where successive slices of your income are taxed at progressively higher rates – means that pay rises are taxed at a higher rate than you paid on your existing income.

Ordinary mortals call this “bracket creep”. Economists call it “fiscal drag”. Either way, the higher rate of tax workers paid on their pay rises also made a bigger-than-expected contribution to income tax collections and the budget balance.

Note that this unexpected move from deficit to surplus in the financial year just past, this underestimation of the strength of tax collections, has implications not only for the size of the government’s debt at June 2023, it has implications for the size of tax collections in the next few years, as well as for the amount of interest we’ll have to pay on that debt this year and every year until it’s repaid (which it won’t be).

In Frydenberg’s budget in March last year, the projected cumulative deficit for the five financial years to June 2026 was just over $300 billion. By the budget in May, this had dropped to $115 billion.

And now that we know last year’s surplus will be about $20 billion, the revised total projected underlying addition to government debt should be well under $100 billion.

Get it? Compared with what we thought less than 16 months ago, the feds’ debt prospects aren’t nearly as bad as we feared. And the size of our “structural” deficit – the size of the deficit that remains after you’ve allowed for the ups and downs of the business cycle – isn’t nearly as big, either.

Which suggests it’s time we had another think about our decision in the late 1970s – along with all the other rich economies – to shift the primary responsibility for managing the macroeconomy from the budget (“fiscal policy”) to the central bank and its interest rates (“monetary policy”).

One of the arguments used by the advocates of this shift was that fiscal policy was no longer effective in stimulating the economy. But our remarkably strong growth since the end of the pandemic lockdowns shows how amazingly effective fiscal policy is.

It’s now clear that fiscal “multipliers” – the extent to which an extra $1 of deficit spending adds to the growth in real GDP – are much higher than we believed them to be.

We know that a big part of the recent leap in prices was caused by shocks to the supply (production) side of the economy arising from the pandemic and the Russia-Ukraine war. But central banks have argued that a second cause was excessive demand (spending), which happened because the stimulus applied to cushion the effect of lockdowns proved far more than needed.

If so, most of that stimulus came from fiscal policy. Our official interest rate was already down to 0.75 per cent before the pandemic began. So, further proof of how powerful fiscal stimulus still is.

But another implication of the $20 billion surplus is that the stimulus wasn’t as great – and its ultimate cost to the budget wasn’t as great – as we initially believed it would be.

In the budget of October 2020, the expected deficit of $214 billion in 2020-21 was overestimated by $80 billion. In the budget of May 2021, the expected deficit of $107 billion in 2021-22 was overestimated by $75 billion. And, as we’ve seen, the deficit for 2022-23 was initially overestimated almost $100 billion.

This says two things: the fiscal stimulus caused the economy to grow much faster than the forecasters expected, even though the ultimate degree of stimulus – and its cost to the budget – was much less than forecasters expect.

Economists know that the budget contains “automatic stabilisers” that limit the private sector’s fall when the economy turns down, but act as a drag on the private sector when the economy’s booming.

We’ve just been reminded that the budget’s stabilisers are working well and have been working to claw back much of the fiscal stimulus, thereby helping to restrain demand and reduce inflation pressure.

Whenever departing Reserve Bank governor Dr Philip Lowe has been reminded of the many drawbacks of using interest rates to manage the economy, his reply has always been: sorry, it’s the only instrument I’ve got.

True. But it’s not the only instrument the government has got. It should break the central bank’s monopoly on macro management and make more use of fiscal policy.

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Friday, July 21, 2023

Covid spending makes bread and circuses too costly for Andrews

These days it’s not unusual for cities to realise they prefer not to host major sporting events such as the Commonwealth Games and Olympic Games. What is unusual is that it’s taken so long for Premier Daniel Andrews to pull the plug.

The later the decision, the greater the disappointment and the ire of organisers, athletes and sport fans. And, no doubt, the greater the wasted spending.

Even so, it does take great political courage – and maybe overconfidence – to make such a decision, especially based on an undocumented claim of such a massive cost overrun – from $2.6 billion to as much as $7 billion.

If there isn’t a political price to be paid at the next Victorian election, it really will prove Andrews’ invincibility – with able assistance from a hopelessly divided opposition.

It isn’t hard to believe that the now-expected cost is far higher than the initial estimate. But the latest estimate of up to $7 billion does stretch credulity.

Overruns are a virtual inevitability in games hosting. This is shown by a table of overruns for the summer and winter Olympics, prepared by researchers at Oxford University.

It shows that Sydney’s stated overrun of 90 per cent in 2000 was on the high side, but nothing to compare with Atlanta in 1996, Barcelona in 1992 and the all-time winner, Montreal in 1976.

Even so, the table does suggest that the size of overruns has fallen in recent times as, presumably, host cities wise up. Perhaps now it’s cities with more experience – and good existing sporting facilities – that are more likely to seek and win the games, or perhaps these days cities know to take more care with their budgeting.

Initially understating the likely cost seems standard political practice for all public projects, let alone major sports events. “It’ll be great fun, bring us the international recognition we deserve, not to mention huge tourist dollars – and it won’t cost all that much.”

But it’s not just the pollies who mislead us. We’re all so keen to enjoy the games at home that we’re easily convinced they won’t cost much and will bring great benefits.

What gives hosting international games such a great risk of blowouts is partly the international sporting body’s demand for many new venues, but mainly the need for them to be completed by a specific, immovable date.

This leaves the games organisers hostage to greedy unions and private contractors.

But there’s rarely a shortage of “independent” consultants willing to take a highly optimistic view of what it all will cost, and what the (always greater) monetary benefits the games will bring in. Even to the extent of putting a dollar value on the supposed “social” benefits they will bring.

It’s all too easy to overestimate the benefit that all the spending by sport fans – local and visiting – will bring. Economists have put much thought into what they call “the economics of special events”, remembering, as most people don’t, to allow for the greatest insight of economics, “opportunity cost” – what your decision to do X means you now won’t be able to do.

Another pertinent concept is “intertemporal substitution” – decisions to move spending between time periods. Remember, too, that the amount of benefit varies with the perspective from which you view it.

Holding the Commonwealth Games in Melbourne, for instance, would attract many visitors from other states, spending on tickets, travel, accommodation, meals and so forth.

From the perspective of the Victorian economy, that’s a benefit. From the perspective of the Australian economy, however, the extra spending in Victoria is cancelled out by the reduced spending in other states.

From a national perspective, the only benefit is from overseas visitors, spending money in Oz that they otherwise wouldn’t have.

Most of the spending would come from Victorians themselves. But it’s likely most of this is money they otherwise would have spent in Victoria on other things, at other times in the year. So, little net benefit to the state’s economy, except for spending by overseas and interstate visitors.

It’s a different matter, however, for the mayors of the five regional cities that were planned to share the hosting of the games. Their cities would have benefited greatly from the spending by visitors from the rest of Victoria, other states and overseas.

Andrews’ decision to regionalise the games was intended to be their special feature, a new model for how the games could be run. But this dispersion seems to have added greatly to the games’ cost. Even at $2.6 billion, Victoria would have been spending much more than other state hosts of Commonwealth Games.

Andrews has promised that the regional cities will still get their planned new sporting venues, but it’s hard to see how this squares with his new view that the state has more pressing spending priorities.

So, just why has Andrews cancelled at this embarrassingly late stage?

He hasn’t said so, but it’s obvious. Because he spent so much coping with the pandemic, and the great debt this has left him with. He has no room left for spending on bread and circuses.

It’s now become common for cities to think twice about their plans to host Commonwealth or Olympic games – though not for them to leave it this late.

It’s noteworthy that Melbourne had no rivals in its bid for these games. And that no other Australia state is interested in filling the vacuum.

Why has hosting become less attractive? Because it’s finally dawning on cities that building so many new sporting venues – which will be little used after the games’ fortnight – is a waste of money that could have been spent on far more lasting and useful things.

But I doubt this means the days of these funfairs are numbered. The international controlling bodies will have to trim their demands for new facilities, and rotate the games between a few cities that have maintained adequate existing venues.

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Wednesday, July 19, 2023

Don't let the political duopoly block the little guys

What could be better for democracy than taking the big money out of election campaigns? Both Victoria and NSW have made moves in this direction, but the feds have done nothing. Until now. The Albanese government’s working on plans for reform.

Last month, the parliament’s Joint Standing Committee on Electoral Matters, now chaired by Labor’s Kate Thwaites, tabled an interim report recommending sweeping reforms to the rules on donations to political parties.

Thwaites wrote that the evidence the committee heard allowed it to “develop clear goals for reform to increase transparency in election donations and curb the potentially corrupting influence of big money, to build the public’s trust in electoral and political processes, and to encourage participation in our elections”.

The committee proposes that limits (“caps”) be set on the maximum permissible donation and the maximum spending by election candidates. Caps would also apply to “third parties”, such as big organisations seeking to influence the election outcome.

The maximum donation that could be made without the donor’s identity having to be disclosed should be lowered from the present $15,200 to $1000. And the disclosure would have to be made at the time, not months later after the dust had settled.

The Labor majority report also urged a new system of increased public funding for parties and candidates in the light of the effect these changes might have in discouraging private donations.

The committee didn’t specify how the caps on donations and spending would work but left it for the government to decide.

Wow. Wouldn’t all that be an improvement? What’s not to like?

Well, I can think of a big risk. At present, the two major parties are at loggerheads, with the Coalition committee members issuing a minority report. They’re particularly – and rightly – opposed to Labor’s desire to regulate donations from big business while exempting donations from big unions.

But as I’ve written before – and will keep writing – the big political development of our time is not the continuing struggle between Labor and Liberal, but the continuing decline of the two-party system of government, as the bad behaviour of both sides turns an ever-growing proportion of voters away to the minor parties and independents.

I think it will become rare for one side to have a comfortable majority, and common to have a minority government. If so, whichever side forms government will be more dependent on winning the support of the crossbenchers – which, I hope, will make them more reformist.

My interest in this is not just that it affects the economic policies governments will be pursuing, but that economists have given much thought to the way small numbers of big firms – “oligopoly” – find ways to compete that are better for them and worse for their customers.

One thing economists know is that the two parties of a duopoly commonly settle into a carve-up of the market that makes life cosier for both of them.

Oligopolists collude – tacitly, of course, since overt collusion is illegal – to keep prices and profits high. This leaves them exposed to some new firm entering their market and taking business away from them by undercutting those excessive prices.

So oligopolists devote much attention to finding ways to raise barriers that stop interlopers entering their market. Often, this involves persuading governments to raise those barriers for them. All for the greater safety of the customer, naturally.

Do you see the parallel with the threat the teals pose to the Liberals, and the Greens pose to Labor? Except that, in the two big parties’ case, when they combine to repel intruders, they don’t have to extract a favour from the government because they are the government.

Surely, there’s some hidden solution to neuter those pesky minor parties that the two big guys could cook up?

Well, the teals, in particular, needed huge donations from badly dressed internet billionaires (and lesser mortals) to knock off so many sitting Liberal members. So maybe we can toughen up on donations in a way that wins much approval and looks even-handed without people noticing it’s disadvantaged the interlopers more than us.

If we have fewer funds from donations, but more public funding, that advantages the established parties because, although every candidate gets the same dollars per vote, the funding you have to spend in this election campaign was determined by how many votes you got last time.

Oh, you didn’t run last time? What a pity.

But that benefit is small compared with the advantages of being the incumbent. Sitting MPs and senators get better paid than most of us, but they also get electoral staff, cars, travel allowances, printing allowances and much else.

All this support is justified as helping the pollie give their constituents good service. But it’s easily diverted to helping them get re-elected. When pollies shake many hands at a school fĂȘte, are they just doing their job, or shoring up their vote? Both.

When the government comes up with its plans to reform election donations and spending, we’ll need to examine their implications carefully.

Read more >>

Monday, July 17, 2023

Bullock the safe choice as RBA governor, but is that what we need?

In Treasurer Jim Chalmers’ decision to accept the internal candidate as successor to Philip Lowe as Reserve Bank governor, we see what may become the ultimate judgment about the Albanese government: it wanted change, but not radical change. Not change that rocked the boat too much. Certainly, not change that got big business offside.

The choice of deputy governor Michele Bullock to move up one chair will delight the Reserve’s higher ranks (though the put-upon lower ranks may have been hoping for a newer new broom to sweep out the old order).

As with most institutions, the Reserve’s insiders want the internally determined pecking order to be preserved. The governor persuades the Canberra politicians to appoint the next-most able person as deputy and, when the time comes, they move up, as do those in the queue behind them.

The Reserve insiders’ great fear is that the pollies will impose one of their trusties on them, or – next worse – that someone from their eternal bureaucratic rival, Treasury, will be appointed to sort them out. Either way, the pecking order is disrupted.

Over the years, the Reserve has had much success in persuading governments to let it choose its own governor. This has been the safe choice for pollies of both colours.

Only once has the internal order been disrupted in (my) living memory, which was when, in 1989, treasurer Paul Keating decided to move his Treasury secretary, Bernie Fraser, from Treasury to the Reserve.

Although I was disapproving at the time, it turned out to be a very healthy development. Fraser brought a breath of fresh air to a fusty institution. He was one of our better governors, a lot more reforming than his predecessors.

Fraser came to fear that one day he’d wake up to find himself reporting to a new Liberal treasurer, Dr John Hewson, a former economics professor, who’d immediately impose on him the latest international fashion, a central bank with operational independence from the elected government, whose decisions on monetary policy (interest rates) would be guided by an inflation target.

That never happened, of course. But Fraser decided that, if this was the way the world was turning, he’d get in first and design his own inflation target, ensuring it was a sensible one.

The Kiwis, who were the first to introduce such a target, set it at zero to 2 per cent, which became the international standard. But, with help from the Reserve’s best people, Fraser decided on something more flexible: to hold the inflation rate between 2 per cent and 3 per cent “on average” over the cycle.

So, it wasn’t just higher than the others. While they had a target with sharp corners, our “on average” would free the Reserve from having to jam on the monetary brakes every time the consumer price index popped its head above 2 per cent.

Foreign officials kept telling the Reserve it should get a proper target like the Kiwis. But in the end, it was they who had to accept their target was too inflexible.

Fraser announced the new target in 1994, by casually dropping it into a speech to business economists. It wasn’t until the next Liberal treasurer, Peter Costello, arrived in 1996, that the target, and the Reserve’s operational independence, were formalised in an agreement between Costello and the new governor, Ian Macfarlane.

Opposition leader Peter Dutton has said that neither present Treasury Secretary Dr Steven Kennedy, nor Finance Secretary Jenny Wilkinson should be appointed to succeed Lowe because they would be “tainted” by their work with the Labor government.

This was ignorant nonsense. He failed to note that both those people were equally “tainted” by their close work with that last Liberal treasurer, Josh Frydenberg, throughout the pandemic.

So it’s worth remembering that, because of Fraser’s close connection to (by then) prime minister Keating, the money market smarties were convinced Fraser wouldn’t be raising interest rates before the 1996 election.

Wrong. He did. Indeed, he raised them before a crucial byelection, which Keating lost in the run-up to losing the election. Since then, governor Glenn Stevens raised rates during the 2007 election campaign, and Lowe during the 2022 campaign.

Getting back to the point, I’d have been happy to see someone from Canberra put in to implement the (more sensible of the) reforms proposed by the recent review of the Reserve’s performance. Such an insular, self-perpetuating institution needs a regular injection of new blood.

With the benefit of hindsight, it’s almost as though Lowe’s speech last week outlining the Reserve’s plans to implement the review’s recommendations – with Bullock having done most of the work on those proposals – constituted her application for the top job.

Or maybe it was the Reserve’s written undertaking to the Treasurer that, should he agree to preserve the order of succession, it would nonetheless faithfully implement the changes needed.

That so many of those changes – which would be of little interest to any but Reserve insiders and the small army of Reserve-watching outsiders – can be described as major reform says much about what a stick-in-the-mud outfit successive governments have allowed it to become.

The number of meetings of the Reserve Bank board will be cut from 11 a year to eight. Really. Wow.

In making that change, the Reserve will continue its practice of having four of its meetings timed to come soon after publication of the quarterly CPI. But it will use the opportunity to have the remaining four meetings come soon after publication of the quarterly national accounts.

The present practice of meeting on the first Tuesday of the month meant it was meeting the day before it found out how fast the economy had been growing.

Get it? The Reserve could have fixed this problem any time in the past several decades by moving its board meetings to fit. But no, it took a full-scale independent review to make it change its practice. We like doing things the way they’ve always been done. (The good news? No more meetings on Melbourne Cup Day.)

The only significant administrative change will be to have decisions about interest rates made by a board better able to argue the toss with the governor. In particular, what they need (and is already in the pipeline) is someone with expertise in real-world wage-fixing.

The real world keeps changing under the feet of economists, and we need central bankers capable of changing their views in an economy where the cause of inflation is changing from excessive wage growth to excessive profit growth.

That requires more debate within the Reserve, and more opportunity for the newly recruited bright young economics graduates to debate matters with the old blokes at the top.

The Reserve’s problem is too much deference to the views and wishes of the governor. It’s long been a one-man band. Bullock’s appointment as the first female governor ends that problem at a stroke. Let’s hope she does better than turn it into a one-woman band.

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Friday, July 14, 2023

Less competition reduces the power of interest rates to cut inflation

The ground has been shifting under the feet of the world’s central bankers, including our own Dr Philip Lowe, the outgoing chief of the RBA. This has weakened the power of higher interest rates to get inflation down.

Like all economists, central bankers believe their theory – their “model” – gives them great understanding of how the economy works and what they have to do to keep inflation low and employment high.

They know, for instance, that inflation – rising prices – occurs when the demand for goods and services exceeds the economy’s ability to supply those goods and services. So they can use an increase in interest rates to discourage businesses and households from spending so much.

This will reduce the demand for goods and services, bringing it into alignment with supply and so stop it causing prices to rise so quickly. It will also slow the rate at which the economy’s growing, of course.

But, with a bit of care, they won’t need to push interest rates so high the economy goes into “recession”, when demand (spending) becomes so weak that the economy gets smaller, causing some businesses to go bust and many workers to lose their jobs.

This theorising has worked reasonably well for many years, leading central bankers to be confident they know how to fix the present surge in inflation.

But the economy keeps changing, particularly as we keep using advances in technology to improve the range of goods and services we produce, and the way we produce them.

One consequence of our businesses’ unending pursuit of labour-saving technology – more of the work being done by machines and less by humans – has not been fewer jobs, but bigger factories and businesses.

As in all the rich economies, many industries are now dominated by just a few huge companies. In our case, we’re down to just four big banks, three big power companies, three big phone companies, two airlines and two supermarket chains. And that’s before you get the handful of giants dominating the rich world’s internet hardware, software and platforms.

Trouble is, when just a few firms dominate an industry, they gain “market power” – the power to hold their prices well above their costs; to increase their “markup”, as economists say.

The size of markups is a measure of the degree of competition in an industry. When competition between firms is strong, markups are low. When competition is weak, markups are high.

There is much empirical evidence that industries in the rich countries have become more concentrated over time, and markups have risen. And, as I’ve written before, Australia’s no exception to this trend.

In economics, “monopoly” means just one seller. “Monopsony” means just one buyer. So, when a firm has a degree of monopoly power, it can overcharge its customers. When a firm has a degree of monopsony power – when workers don’t have many employers to pick from – it can underpay its workers.

Researchers have found much evidence of labour-market power. And again, I’ve written before about the evidence this, too, is happening in Australia.

But this week, at the annual Australian Conference of Economists, federal Competition Minister Andrew Leigh, himself a former economics professor, drew attention to two recent International Monetary Fund research papers suggesting that a lack of competition is reducing the effectiveness of monetary policy – the manipulation of interest rates – in influencing inflation.

The first paper, by Romain Duval and colleagues, uses American data and data from 14 advanced economies to find that, compared with low-markup firms, high-markup firms are less likely to respond to changes in interest rates. The level of their sales changes less, as do their decisions about future investment in production capacity.

So, fat markups mean companies are less likely to change their behaviour. They’re not likely to cut their investment spending, for example.

This means more of the pressure to respond to higher rates will fall on households with big mortgages, but also on firms with low markups.

The second paper, by Anastasia Burya and colleagues, uses online job ads from across the United States to find that in regions where firms have a lot of labour-market power – that is, where workers don’t have much choice of where to work – those firms can hire workers without having to offer higher wages to attract the people they need.

This is the opposite of what standard theory predicts. It’s bad news for workers, who could have expected strong demand for labour to push up wages.

But another way to look at it is that, where big firms have labour-market power, there’s little relationship between employment and the change in wages. If so, conventional calculations of the “non-accelerating-inflation rate of unemployment” – the lowest point to which unemployment can fall without causing wages to take off – will give wrong results, encouraging central banks to keep unemployment higher than it needs to be.

And at times when price inflation is too high, unemployment will have to rise by more than you’d expect to get the rate of inflation back down to where you want it. How do you bring about a bigger rise in unemployment? By increasing interest rates more than you expected you’d have to.

So, whether it’s inadequate competition in the markets for particular products, or inadequate competition in the market for workers’ labour, lack of competition makes monetary policy – moving interest rates – less effective than central bankers have assumed it to be.

The model of how markets work that central bankers (and most other economists) rely on assumes that the competition between firms – including the competition for workers – is intense.

In the real world, however, markets have increasingly become dominated by just a few huge firms, which has given them the power to keep prices higher than they should be, and wages lower than they should be.

Leigh, Minister for Competition, gets the last word: “If you care about central banks being able to do their jobs, then you should care about a competitive and dynamic economy.”

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Wednesday, July 12, 2023

Robodebt: Politicians behaving badly to win our approval

Cliches become cliches because so many people see how aptly they capture a situation. My rarely achieved goal is to initiate them rather than reuse them. But at least let me be the first to see how aptly one applies to the robo-debt scandal, by paraphrasing Thomas Jefferson: we get the politicians we deserve.

You may not know it, but there once was a time when the convention – rigorously policed by Yes, Minister-style bureaucrats – was that incoming governments did not inquire into the doings of their predecessors.

But that convention was breached a long time ago, and now it’s conventional for every newly elected government to immediately initiate formal inquiries into the misdeeds – actual or supposed – of the government the voters have just thrown out.

It’s become another of the many advantages of incumbency. You improve your chances of a prolonged period in power by discrediting your traditional opponent in the eyes of the electors.

The first such inquiry I remember was the Costigan royal commission into the notorious activities of the Ship Painters and Dockers Union, called by Malcolm Fraser’s Coalition government in 1980, in the hope of embarrassing Labor.

The Howard government established another anti-union royal commission, into the building construction industry, and the Abbott government set up royal commissions into the Rudd government’s ill-fated “pink batts” home insulation program, and into trade union governance and corruption, hoping to embarrass the then Labor leader, Bill Shorten. So it may not be a simple coincidence that Shorten was the minister who commissioned the robo-debt inquiry.

I was once a supporter of the no-looking-back convention, but now I see that the decline in standards of political behaviour require governments to be held more strictly to account – if only in retrospect. When you think about it, the old gentlemanly convention – that dog doesn’t eat dog – arose from the two political sides colluding to make their lives easier at the expense of the public’s knowledge of what they’ve been up to.

So, it’s a good thing that this royal commission has shone a bright light on robo-debt as “a crude and cruel mechanism, neither fair nor legal” that made many people on the dole and other benefits “feel like criminals”.

“In essence, people were traumatised on the off-chance they might owe money,” the commissioner concluded.

The Liberal ministers who initiated and had oversight of this horrendous scheme should face the music, and those ministers who allowed it to run on for years despite its iniquities being well known (I wrote about them in early 2017) should be ashamed.

But while we’re all pointing accusatory fingers at the former government, I don’t think the rest of us should get too high on our high horse. Most of us don’t come out of this episode with clean hands.

The truth is, most of us knew – or certainly could have known – what was going on, but weren’t too bothered by it. We didn’t inquire further.

When the opportunity arose to disgrace its political opponents, the Albanese government knew where the bodies had been buried but, at the time, the Labor opposition didn’t make a great fuss about robo-debt.

Media outlets love boasting about the royal commissions their investigations have forced on reluctant governments but, with an honourable exception or two, they can claim little credit for this one. This one’s a win for the #notmydebt victims using social media.

People are right to see the former government as being utterly, shockingly lacking in compassion in its treatment of people falsely accused of owing the government money. For such a measure to be initiated by someone proud to proclaim his Christian faith is truly shocking.

But it’s wrong to see these people just as ruthless debt collectors, determined to cut government spending by fair means or foul. Scott Morrison wanted to be seen as the tough welfare cop.

The government wanted to be seen getting rough and tough with dole bludgers because it knew many voters would find it gratifying.

Labor knows it, too. That’s why it wasn’t making much fuss at the time. And why, in the May budget, it rejected expert advice that it greatly increase the rate of the JobSeeker payment to stop it being well below the poverty line.

Both sides of politics know there’s much “downward envy” among Australians. Hard-working, tax-paying people who greatly resent those people – mainly youngsters – who prefer sitting around at home rather than getting out and finding a job, but still have the government giving them money.

There are many reasons I’m proud to be an Australian. But one thing that makes me ashamed is the way our politicians seek popularity by pandering to the worst side of the Australian character: our tendency to scapegoat those less fortunate than ourselves, particularly boat people and the jobless.

Like Joe Hockey, we see ourselves as “lifters”, and greatly despise those we regard as “leaners”.

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Friday, June 23, 2023

Enjoy the wonderful land of full employment - while you can

I hope that while you’re complaining about the cost of living, you’re also wallowing in the joys of living in an economy that’s reached the sacred land of “full employment” – being able to provide a job for almost everyone who wants one. This is the first time we’ve seen it in 50 years.

You have to say we’ve achieved it not by design, but as an unexpected consequence of our bumbling attempts to cope with the vicissitudes of the pandemic.

We used interest rates and, more particularly, the budget, to stimulate demand (encourage business and consumer spending) and ended up doing a lot more than we needed to. To the economy managers’ surprise, the rate of unemployment fell rapidly to 3.5 per cent – a level most of them had never seen before and never expected to see.

The sad truth is that, during the half century that the high priests of economics were wandering in the wilderness of joblessness, they lost their faith, and started worshiping the false god Nairu, who whispered in their ears alluring lies about the location they were seeking.

But now the wanderers have stumbled upon the promised land of Full Employment, a land flowing with milk and honey.

So now’s the time for us all to sing hymns of praise to one true god of mammon, Full Employment, in all its beneficence and beauty. And here to be our worship leader is Michele Bullock, deputy governor of the Reserve Bank, who published some new soul music this week.

Bullock says it’s “hard to overstate the importance of achieving full employment. When someone cannot find work, or the hours of work they want, they suffer financially. However, the costs of unemployment and underemployment extend well beyond financial impacts.

“Work provides people with a sense of dignity and purpose. Unemployment – particularly long-term unemployment – can be detrimental to a person’s mental and physical health,” she says.

“The costs of not achieving full employment tend to be borne disproportionately by some groups in the community – the young, those who are less educated, and people on lower incomes and with less wealth.

“In fact, for these groups, improved employment outcomes and opportunities to work more hours are much more important for their living standards than wage increases.”

Early in the pandemic and the imposition of lockdowns, we thought we were in for a regular recession. And “the sobering experience from previous recessions had taught us that these episodes leave long-lasting marks on individuals [called “scarring” by economists], communities and the economy.

“For example, if people stay unemployed for too long, their skills may deteriorate or become obsolete and their prospects for re-engaging in meaningful work may decline. This can result in more people in long-term unemployment or, alternatively, people withdrawing from the workforce,” Bullock says.

But, thanks to all the up-front stimulus, there was no recession and, hence, no scarring. Instead, outcomes in the labour market over the past three years “have consistently exceeded the expectations of the Reserve Bank and other forecasters”.

In fact, the share of the Australian population in employment has never been higher – higher even than in the decades between the end of World War II and the mid-1970s, when full employment became the norm.

Today, the number of Australians in a job has increased by more than 1.1 million since late 2021, and the level of employment is now almost 8 per cent above its pre-pandemic level. Get that.

Almost all the gains in employment since the start of the pandemic have been full-time jobs. Strong demand for labour has enabled many previously part-time employees to move into full-time work. This has pushed the underemployment rate – the proportion of people with jobs, but seeking more hours – down to its lowest since 2008.

Bullock says the people who’ve benefited most from all this are those on lower incomes and with less education. Unemployment has tended to decline more in local areas that had weaker employment to begin with.

Young people – those aged 15 to 24 years – who usually suffer most when recessions occur, have seen their rate of unemployment decline by more than twice the decline in the overall unemployment rate.

Long-term unemployment is defined as being without work for more than a year. Last year, a record number of the long-term unemployed found a job, and fewer gave up looking for one.

What’s more, the risk of not being able to find a job within a year declined significantly. So the rate of long-term unemployment is close to its lowest in decades.

Wow. Now, Bullock’s not exaggerating when she says it’s hard to overstate the many benefits – economic and social – of achieving full employment.

But she’s harder to believe when she assures us that, just because the Reserve has hardly spoken about anything other than the need to reduce inflation for the past year and more: “it does not mean that the other part of our mandate – maintaining full employment – has become any less important.

“Full employment is, and has always been, one of our two objectives.”

Well, I’d love to believe that was true, but both the Reserve’s present rhetoric and behaviour, and its record, make it hard to believe.

The Reserve has had independent control over the day-to-day management of the economy for more than 35 years. For almost all of that time we’ve had low inflation, but only now have we achieved full employment – and only by happy accident.

For most of that time it, like most macroeconomists the world over, has been listening to the siren call of the false god Nairu – aka the “non-accelerating-inflation rate of unemployment” – telling it that “full employment” really means an unemployment rate of 5 per cent or 6 per cent.

If you dispute that, answer me this: how many times in the past 35 years has a Reserve Bank boss been able to make a similar speech to the one Bullock gave this week?

Read more >>

Wednesday, June 21, 2023

My version of how 'net zero' will change our lives: not much

I think by now almost all of us are agreed that, to reduce climate change, we’ll have to achieve “net zero emissions” of greenhouse gases by 2050. But that’s a very tall order, involving much change to existing industries – many of which will continue seeking to delay the inevitable – and change in the way you and I use energy. So, how on earth is it going to come about?

We see the Albanese government and the state governments setting targets and beavering away on various parts of the puzzle, but if the feds have a grand plan for how it all comes together they’re doing a good job of keeping it to themselves.

So let me have a stab at detecting the method in our leaders’ madness. I’ll be leaning heavily on the work of the one person who is thinking out loud about how we can get to the 2050 objective, Tony Wood of the Grattan Institute.

First, let me acknowledge the truth the climate change deniers and foot-draggers make so much of: nothing we Australians do will stop the globe warming unless the other major emitting countries – America, China and those in the European Union – also achieve net zero emissions by 2050.

This is why, though we’ve known about the problem for decades, we’ve achieved so little to date. It’s just so easy to use others’ inaction as an excuse for our own. The truth is, all we can do is set a good example and urge the others to do likewise. Under the previous federal government, we were setting a bad example.

But remember this: our part in reducing global emissions is bigger than just reducing our own because we’re also one of the world’s largest exporters of fossil fuels. We need to reduce our complicity in other countries’ emissions by at least ceasing to expand our existing coal mines and gas fields.

Getting to net zero largely involves eliminating our use of coal, oil and gas, and replacing them with renewable sources of energy.

This history-making break from the past won’t happen by magic. Nor by sitting back and waiting for market forces to bring it about. No, it won’t happen until the government has the courage to make it happen, by saying just what has to happen, and by when.

As with the pandemic, and most of the problems we face, the responsibility is shared between the federal government and the states. This means the feds must take the lead, but in close consultation and co-operation with the states. Since the feds have most control over the purse strings, the wheels of co-operation are greased by offers of money.

As I see it, the basic strategy is simple: switch the production of electricity from coal and gas to renewables and batteries, and use clean electricity to replace the use of oil and gas. The beauty of this great reliance on electricity is that, though it will mean much disruption of particular industries, it doesn’t involve much disruption to the way we run our households.

Much of the heavy lifting with the major industrial emitters will be done by Climate Change Minister Chris Bowen’s recent reforms to the “safeguard mechanism”, aimed at achieving the promised 43 per cent reduction in emissions by 2030.

Much of the progress in eliminating our use of oil will come from shifting to electric vehicles. Make sure your next car is electric, and you’ve got that box ticked with minimal disruption to your life. It’s the various governments’ job to get the price of EVs down to something more reasonable and ensure sufficient charging points.

Which brings us to the elimination of natural gas, the subject of Wood’s Grattan report earlier this week. It would suit the blatant self-interest of the gas industry for gas to be seen as the “transition fuel”: we move electricity production from coal to gas and later to renewables.

But 2050 – and even worse climate change - isn’t that far away, and we don’t have time for a leisurely transition. We must move straight to renewables and storage (batteries), using gas to provide only residual capacity, balancing the last 10 per cent or so.

Household use of gas – for cooking, water heating and space heating – is big only in Victoria, NSW and the ACT. About 30 per cent of Australian homes are already all-electric, and Wood calculates that about 40 per of those that have gas are in a position to upgrade to all-electric.

Although electric appliances are dearer than gas appliances, electricity itself is cheaper – meaning savings longer-term. It’s also cleaner and free of fumes that damage your health. So, being obliged to become all-electric is no great imposition. Even so, governments should move all their own social housing to all-electric, offer tax incentives to landlords and low-interest loans to homeowners.

Governments should ban new gas connections and phase out the sale of gas appliances, so the last remaining gas appliances are replaced with electric. Set firm rules and deadlines, and we can rely on market forces to do the rest.

Read more >>

Monday, June 19, 2023

Maybe Lowe should stay on as governor to clean up any spilt milk

I’ve never liked making free with the R-word until it’s an undeniable reality. Too many journalists refuse to recognise that if enough people in positions of influence predict bad things enough times, their predictions have a tendency to become reality.

But I confess I’m starting to worry that Reserve Bank governor Dr Philip Lowe – a man who, until now, I’ve always regarded as having steady judgment – is pressing harder on the interest-rate brakes than he needs to. And I don’t think I’m the only economy-watcher who shares that fear.

He seems to be seizing on any argument that says he should give the thumbscrews another turn, while ignoring all the arguments that say he’s already done enough. The Fair Work Commission has awarded the people whose wages constitute the bottom 10th of the national wage bill a 5.75 per cent pay rise. Oh, no! Give it another turn.

Employment grew by 76,000 in May and the unemployment rate went down a fraction. Oh, no! Give it another turn.

One of the rules of using interest rates to suppress demand is that they work with “long and variable lags” so that, if you keep tightening until it’s clear you’ve done enough, you’ve already done too much and will crash the economy. But Lowe seems to have forgotten this.

Another thing he seems to have forgotten is that, in times past, we’ve needed a big increase in interest rates to slow a booming economy because the boom has resulted in real wages growing so strongly.

Not this time. This time an unusual feature of the boom has been that real wages have been falling for several years. Do you realise that real labour costs per unit of production are now 6 per cent lower than they were at the end of 2019?

What’s been (conveniently) forgotten is that, in the early days of the pandemic, when we imagined we were in for a severe recession, employers were quick to demand a wage freeze, to which workers readily acquiesced.

Turned out that a couple of lockdowns don’t equal a recession, and employers did fine. But there was no suggestion of a catch-up for the wage freeze that wasn’t needed. Remember this next time you see Lowe banging on about the worrying rise in nominal labour costs per unit.

If Lowe knew more about how wages are fixed in the real world, rather than in economics textbooks, he’d have noticed that the union movement’s failure to talk about the need for a wage catch-up was a sign of its diminished bargaining power.

(He’d also be more conscious that the conventional economic model’s implicit assumption – that the parties to every transaction are of roughly equal bargaining power – doesn’t hold between an employer and an employee. Nor between a big business and a small business, for that matter.)

Then there’s Lowe’s invention of a new doctrine (one previously exclusive to bull-dusting employer groups) that workers need to produce more if they want their wages merely to keep up with inflation.

Lowe professes to be terribly worried about a fall in the productivity of labour in recent quarters but, as The Conversation website’s Peter Martin has reminded us, falling productivity (output per hour worked) is exactly what you’d expect to see at a time when falling unemployment is returning us to full employment.

Employers have preferred to hire more workers rather than buy more labour-saving machines. And, as the econocrats have pointed out, they’re having to hire more of the kinds of workers they usually prefer not to hire – the young, the old and the long-term unemployed.

That is, they’ve had to start hiring the less-productive. This is a bad thing, is it?

One reason I’m shocked by Lowe’s newly invented line that, absent productivity improvement, all wage growth above 2.5 per cent is inflationary, is that I was around in the 1970s when wage growth really was excessive and inflationary. It was to be condemned then; but anyone saying it now has moved the goal posts.

It was then that Treasury made so much fuss about labour costs per unit that the Bureau of Statistics began publishing the figures every quarter – the ones Lowe has been leaning on so heavily.

But when the Australia Institute think tank copied the method used by the European Central Bank (and now by the Organisation for Economic Co-operation and Development) to calculate profits per unit, the econocrats wrote learned treatises saying its method was “flawed”. Apparently, sauce for the wages goose is not sauce for the profits gander.

Speaking of flaws, the flaw in Lowe’s new-found argument that wage rises exceeding 2.5 per cent, but less than the rise in prices, are inflationary ought to be obvious to anyone not blinded by pro-business bias. It doesn’t add to the inflation rate, but it does add to the time it takes for the inflation rate to fall back.

So, what Lowe’s on about is the speed at which inflation is returning to (the now unrealistically low) target range of 2 to 3 per cent. And he’s in such a tearing hurry he’s prepared to risk causing a recession.

Why? Well, what I wonder is whether Lowe’s expectation that his term as governor won’t be renewed in September – so a new governor can make the changes the Reserve Bank review has recommended – is affecting his judgment.

There’s a concept in economics called “revealed preference” which says: judge people not by what they say, but what they do. Lowe says he’s aiming for the “narrow path” to low inflation without a recession.

But what he seems to be aiming for is low inflation come hell or high water. I wonder if he’s decided he prefers not to be remembered as the governor who let inflation get out of control, but left without fixing it.

If, to avoid that fate, he has to be remembered as the guy who plunged the economy into a recession no one thought was needed, then them’s the breaks.

The sad truth about independent central banks is that, if they really stuff up, it’s the elected government that gets blamed. Since there’s no voting for who’s to be governor, there’s no other way voters can register their disaffection.

So, if Lowe continues finding excuses to tighten the monetary screws, don’t be surprised if the Albanese government gets ever less muted in its criticism.

But if I were Treasurer Jim Chalmers, I’d consider postponing the reform of the Reserve’s procedures and extending Lowe’s term, so his mind could be fully focused on achieving the soft landing – or be around to share the blame if he crashes the plane. And help mop up the debris if he fails. This may also stop him acting so uncharacteristically.

Read more >>

Friday, June 16, 2023

We're investing more overseas than foreigners are investing here

 For pretty much all of Australia’s modern history, our strategy for getting more prosperous was to be a “net importer of [investment] capital” from the rest of the world. But four years ago, that was turned on its head, and we became a net exporter of investment capital.

If you think that doesn’t sound like a good thing, I agree with you – though probably not for the same reason as you. I think it does much to explain why the economy – and the productivity of our labour – have grown so weakly over the past decade. And are likely to continue growing slowly once the Reserve Bank has beaten inflation out of our system.

How come you haven’t heard about this historic turnaround? Because, though economists hate to admit it, economics is subject to fashions, and for many years they haven’t been much interested in talking about what’s happening in the economy’s “external sector”, which accounts for about a quarter of the whole economy.

All of Australia’s households’, businesses’ and governments’ economic dealings with the rest of the world during a period are summarised in a document called the “balance of payments” – payments to foreigners and payments from foreigners.

The balance of payments is divided into two accounts, the “current” account and the “capital and financial” account.

The current account shows the value of our exports of goods and services ($171 billion in the latest, March quarter) less the value of our imports of goods and services ($129 billion), to give us a trade surplus for the quarter of $42 billion.

But then it takes account of our interest and dividend payments to foreigners of $57 billion, less their payments of interest and dividends to us of $24 billion, to give us a “net income deficit” of $33 billion.

Subtracting this deficit from the trade surplus of $42 billion leaves us with a surplus on the current account for the quarter of $9 billion.

So, we ended up making a profit during the quarter, as we have in every quarter for the past four years, whereas for almost every year before that we ran deficits. We’ve made some progress.

Is that what you think? Sorry, as the father of economics, Adam Smith – born 300 years ago this year – spent his life explaining, this “mercantilist” notion that a country gets rich by trying to export more than it imports is wrong.

We benefit from importing the things that other countries do better than we do, and they benefit from us exporting to them the things we do better than they do. Economists call this the “mutual gains from trade”.

In any case, like the accounts of every business, the balance of payments is based on “double-entry bookkeeping”, where every transaction is seen as having two, equal sides, a debit and a credit. So, it’s wrong to think that debits are bad and credits are good.

Similarly, it’s wrong to think that the resulting deficits (debits exceed the credits) are bad, and surpluses (credits exceed the debits) are good.

And remember that the “current” account is only one half of the balance of payments so, since the debits and credits are always equal, if we’re running a surplus on the current account, we must be running a deficit of equal size on the other, capital and financial account.

Until four years ago, we always ran a surplus on the capital account, but now we’re running a deficit. But what does this switch actually mean?

It means that, until recently, our households, businesses and governments always spent more on investment – in new housing, new business equipment and structures, and new public infrastructure – than they could finance from their own savings.

(Households save when they don’t spend all their income on consumption. Businesses save when they don’t pay out all their after-tax profits in dividends. Governments save when they raise more in taxes than they spend on their day-to-day activities.)

How can we, as a nation, spend more on new physical investment than we’re able to finance with our own saving? By getting the extra savings we need from abroad. We can borrow it, or we can allow foreigners to own Australian businesses or real estate.

And that’s exactly what we did until four years ago. We borrowed overseas and let foreigners own “equity” in our economy. This is what it means to say Australia was a “net importer of capital”.

Why did we do that? Because we had more opportunities for economic development than we could finance from our own saving, and figured that allowing foreigners to join us in investing in our economy would leave us better off.

The consequence was that, for more than 200 years, our economy grew faster and our standard of living improved faster than if we’d kept everything to ourselves.

So, what’s changed? Why have we switched to being a net exporter of investment capital? Why have we begun investing more of our savings in other countries than they’ve been investing in Oz?

Partly because the build-up of our compulsory superannuation system means we, as a nation, are saving a lot more of our income than we used to.

Now here’s the killer: but also because, particularly since the end of the mining investment boom a decade ago, we’ve been investing a lot less in improving and expanding our businesses.

You wonder why, until the government and the Reserve Bank mistakenly caused the present brief inflationary surge, the economy’s growth was so weak? Now you know.

You wonder why the productivity of our labour’s been improving so slowly? Because we haven’t had enough business investment in new and better machines. Or in research and development, for that matter.

And the main thing we’ve got to show for this deterioration is a current account surplus. You beaut.

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Thursday, June 15, 2023

THE GLOBAL ECONOMY

Aurora College Economics HSC Study Day, Sydney

Every year there’s some event in the news that’s relevant to your study of the global economy, and this year it’s the growing realisation that the process of globalisation has stopped and begun to reverse – “deglobalisation”. The pandemic hasn’t helped, nor has the invasion of Ukraine, but it’s the increasing tension between the US and China that has raised the spectre of the world being divided into two rival trading blocs. It’s likely the value of world trade will fall in 2023.

The arrival of the pandemic in early 2020 led to an immediate fall in world trade, but it recovered sharply the following year. However, the disruption to the supply of many imported goods has led some countries and companies to “re-shore” their supply chains, by producing more goods and components at home rather than abroad. While making their supply more reliable, this will raise the cost of those products. For some, this has just been the latest excuse for protection against competition from imports. The IMF has argued that supply chains can be diversified – made reliant on a wider range of foreign suppliers – without losing the benefits from trade.

The invasion of Ukraine has disrupted the supply of oil and gas from Russia to many European economies, as well as the supply of wheat and other foodstuffs to developing countries. This has happened not so much because of the war as because of the trade sanctions imposed on Russia by the US and its many allies. As the war drags on, the Europeans and others move to alternative suppliers, a process known as “friend-shoring” – moving your trade to countries you get on with, not necessarily those offering the best prices or service.

America’s swing to protectionism

For many decades, the US was the great champion of free trade and rules-based trading under the GATT – the General Agreement on Tariffs and Trade – and its successor, the World Trade Organisation. It was the support of the US that allowed China to become a member of the WTO in 2001, leading to huge growth in international trade and globalisation. Much manufacturing activity moved to China from the developed economies, leading to decades of lower prices for manufactured goods throughout the world, and the accelerated growth of the Chinese economy. But it also led to much unemployment for displaced factory workers in the US. While all consumers benefited from the cheaper imports, far too little was done to help those workers find employment elsewhere. This was the grass-roots cause of America’s swing to protectionism.

President Donald Trump won election in 2016 on a promise of protecting American industry against “unfair” competition from developing countries and, in particular, China. He launched a trade war with China, made changes to various trade agreements, and refused to join a US-sponsored trade agreement with Japan, Australia and various other Asian economies (which went ahead anyway). What’s now apparent is that US protectionism, and the trade war with China, have continued under President Joe Biden. He has resorted to subsidies and export controls, contrary to WTO rules.

It's now clear the US is motivated not just by protectionism, but also big-power rivalry with China. America is unwilling to share power with the rising superpower, China. It is particularly unwilling to have China overtake it as leader in advances in digital technology. When politicians and officials say they are worried about the effect of “geostrategic conflict” on world trade, this is what they mean. When they worry about the “fragmentation” of world trade, they mean they fear the world could divide into two rival trading blocs, led by America and China. This would involve great losses of the “gains from trade” through pursuit of “comparative advantage”. In October 2022, the US imposed sweeping restrictions on exports of semiconductors (chips), aimed at preventing China from advancing technologically. This also explains America’s efforts to stop Huawei and TikTok from expanding outside China.

Definition

The OECD defines globalisation as “the economic integration of different countries through growing freedom of movement across national borders of goods, services, capital, ideas and people”.

That’s a good definition, but I like my own: globalisation is the process by which the natural and government-created barriers between national economies are broken down.

Globalisation’s two driving forces

With this definition I’m trying to make a few points. One is that globalisation has had two quite different driving forces. The one we hear most about is the decisions of governments around the world to break down the barriers they have created to limit flows of goods and money between countries by reducing their protection of domestic industries and by deregulating their financial markets and floating their currencies.

But the second factor promoting globalisation is just as important, if not more so: advances in technology – including advances in telecommunications, digitisation and the internet, which have hugely reduced the cost of moving information and news around the world, as well as increasing the speed of its movement. This has allowed a huge increase in trade in digitised services. As well, advances in shipping – containerisation, bigger and more fuel-efficient ships – and in air transport have led to increased movement of goods and people between countries.  

Globalisation is a process

Another point my definition makes is that globalisation is a process, not a set state of being. Because it’s a process, it can go forward – the world can become more globalised – or it can go backwards, as national governments, under pressure from their electorates, seek to stop or even reverse the process of economic integration. Among the advocates of globalisation there tended to be an assumption that the process of ever greater integration was inevitable and inexorable. That was always a mistaken notion.

Earlier globalisation

The process of globalisation is and always was reversible. People should know this because this isn’t the first time the process of globalisation has occurred and then been rolled back. The decades leading up to World War I saw reduced barriers and greatly increased flows of goods, funds and people between the old world of Europe and the new world of America, Australia and other countries. But this integration was brought to a halt in 1914 by the onset of a world war. And the period of beggar-thy-neighbour increases in trade protection, to which countries resorted in response to the Great Depression of the early 1930s, greatly increased the barriers between national economies. Indeed, in the years after World War II, the many rounds of multilateral tariff reductions brought about under the GATT – the General Agreement on Tariffs and Trade, which has since become the World Trade Organisation – were intended to dismantle all the barriers to trade built up in the period between the wars.

The era of hyperglobalisation

The period between the end of World War II in 1945 and the late 1980s saw huge growth in trade between the advanced economies, as a consequence of those successive rounds of tariff reductions. But from the late ’80s until the global financial crisis and Great Recession of 2008 there was a period of “hyperglobalisation” in which trade between the developed and developing countries grew hugely. This was partly because of the way the digital revolution and other technological change broke down the natural barriers between countries. But also the result of the eighth and final “Uruguay round” of the GATT in 1994 reducing tariff and other trade barriers between the developed and developing countries.  Many poor countries joined the new WTO at this time, with China joining in 2001.

One measure of the extent of globalisation is the growth in two-way trade between countries (exports plus imports) as a proportion of gross world product (world GDP). Between 1990 and 2008, global trade rose from 39 pc to 61 pc of GWP – the period of rapid globalisation.

Note that the poor countries did well out of the quarter-century of rapid globalisation. Between 1995 and 2019, real GDP per person in the emerging economies more than doubled, whereas in the advanced economies it grew by only 44 pc (after allowing for differences in purchasing power).

The era of deglobalisation

But the end of hyperglobalisation can be dated to the global financial crisis in 2008, and the new era of “deglobalisation” has continued during the pandemic. Two-way trade as a proportion GWP fell after the global financial crisis, and even by 2019 had not regained its peak in 2008.

Among the signs of deglobalisation are Britain’s vote in 2016 to leave the European Union – Brexit – and thus to reduce its degree of economic integration with the rest of Europe – a decision most outsiders see as involving a significant economic cost to the Brits’ economy. Second, the Trump administration withdrew from the Trans Pacific Partnership, an agreement between the US and 11 other selected countries (including Australia) to reduce barriers to trade between them – although the remaining 11 finalised an agreement without the US.  Third, the Trump administration withdrew from the Paris global agreement on reducing greenhouse gas emissions. Fourth, Trump launched a trade war with China. President Biden has re-joined the Paris agreement and repaired America’s relations with its allies, but continues the contest with China.

The temptation of returning to protectionism

The period of hyperglobalisation saw the shift of much manufacturing from the rich countries (including Australia) to China and other developing countries with cheaper labour. But it’s likely that, in the period of slower growth that followed the global financial crisis, some countries yielded to the temptation to return to protecting their domestic industries against foreign competition, returning to the (failed) strategy of growth through “import replacement” rather than “export-led” growth. Regrettably, this trend is being led by the two biggest developing economies, China and India. China raised its import barriers against many Australian exports, but is now lowering them.

This trend has continued during the pandemic, with The Economist magazine reporting that countries have passed more than 140 special trade restrictions during the pandemic. Some of these may arise from concerns in the rich countries during the pandemic over the lack of availability of personal protective equipment, or vaccines. Worries about the pandemic’s disruption of global supply chains may be another reason for the return of protectionist attitudes in the advanced economies.

The channels of globalisation

The four main economic channels through which the world’s economies have become more integrated are:

1) Trade in goods and services

2) Finance and investment

3) Labour

4) Information, news and ideas.

Trade is probably the channel that gets most attention from the public. Donald Trump’s populist campaigning against globalisation focused on the belief that America’s greater openness to trade – particularly with developing countries – caused it to lose many jobs, particularly in manufacturing, as cheaper imports caused many domestic producers to lose sales, or as factories have been moved offshore to countries where wages are lower, without America receiving anything much in return.

Surprisingly, financial globalisation didn’t get as much blame as it could have for the global financial crisis and the Great Recession it precipitated. Most countries have not liberalised the flow of labour into their economy in the way they have the other factors of production.

Income distribution and the gains from trade

One of economists’ core beliefs is that there are mutual gains from trade. Provided the exchange of goods is voluntary, each side participates only because it sees some advantage for itself. This is undoubtedly true, but in the era of renewed globalisation we’ve been reminded that, though the gains may be mutual, they are not necessarily equal. Some countries do better than others.

Similarly, the benefits to a particular country from its trade aren’t necessarily equally distributed between the people within that country. When, for example, a country imports more of its manufactured goods because they are cheaper than its locally made goods, all the consumers who buy those goods are better off (including all the working people), but many workers in the domestic manufacturing industry may lose their jobs.

Another factor that has been working in the same direction is digitisation and other technological change which, in its effect on employers’ demand for labour, seems to be “skill-biased” – that is, it tends to increase the value of highly skilled labour, while reducing the value of less-skilled labour. It seems likely that, between them, trade and technological advance have worked to shift the distribution of income in America, Britain and, to a lesser extent, Australia, in favour of high-income families and against many middle and lower-income families.

The unwelcome surprise many politicians and economists have received from the high protest votes for Brexit, Trump and One Nation is causing them to wonder if too little has been done to assist the workers and regions adversely affected to retrain and relocate, and too little to ensure the winners from structural change bear most of the cost of this assistance.

Shares of the World Economy, 2021


GWP Exports Population


China          19   13     18

United States   16     9         4

Euro area (19 countries)   12   26         4

India     7     2       18

Japan     4     3         2



Advanced economies (40) 42   61       14

Developing economies (156) 58   39       86

            100 100     100


Source: IMF WEO statistical appendix; GWP based on purchasing power parity                


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